• All rates expected unchanged. Rates are currently: Refinancing 0.00%, Deposit -0.40% and Marginal Lending 0.25%
• The main focus of this meeting is once again touted to be whether there is an extension to the duration of the ECB’s QE program
• If the ECB choose to extend the QE program, measures will likely be taken in order to appease concerns of bond scarcity

Background

The rate decision itself from the ECB is yet again expected to be a non-event, with no notable commentators suggesting there will be a rate cut, instead all the speculation surrounds if and how the central bank may choose to extend the QE program, which is currently due to expire in March 2017. The general consensus is that the ECB will choose to expand their accommodative actions, however the way in which they will choose to do so is less clear, it is also worth noting that Draghi and Co. may choose to hold fire and announce an extension at a later date.

If the ECB choose to extend their QE program, there are 4 main guises that this action could take: The most likely option is that the program could be extended by a further 6 months until Autumn 2017 at the current pace of EUR 80bln per month; the ECB may instead choose to commit to a 3 month extension and state they will reassess in June 2017; another potential choice would be to commit to a longer extension of 9 or 12 months, but with the option to reassess the pace on a regular basis (touted to be every quarter in line with ECB forecasts); the final, and least likely, touted possibility would be to extend the program but by a lower amount (perhaps EUR 60bln per month), which would effectively amount to a tapering strategy.

Any expansion of the ECB’s QE program would have to be accompanied by measures to avoid bond scarcity, an issue which is currently plaguing the central bank’s attempt to remain accommodative. In terms of potential action, we may see a deviation from the capital key to see greater flexibility across countries, or an inclusion of regional debt to see a greater number of issuers included. Conversely, the ECB may choose to allow purchases below the deposit rate, thus avoiding the currently constraining floor.

As a guide to recent ECB rhetoric, sources have suggested that a large majority of ECB policy makers are in favor of extending beyond March 2017, so if no extension was announced markets could experience extreme volatility, particularly given the optimism from ECB’s Draghi’s latest commentary, which suggested that European recovery is firm, while Coeure has reiterated that QE tapering talk is premature.

Market Reaction

The majority of the volatility from the ECB meeting will be felt during Draghi’s press conference unless, as was the case in March where the ECB announced an increase to the APP and TLTRO program, the central bank announce the new policy at 1245GMT in tandem with the rate decision. If the ECB extend by less than 6 months or highlight the potential upside in the economy, which has seen the 5y5y inflation rate at its highest level since Dec’15; then you could see immediate downside in equities, upside in EUR and a flattening of the curve. While if Draghi extends by 6 months or offers a cautious outlook, the opposite could be seen – upside in equities and softness in the EUR, with further upside possible in Bund futures.

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