ECB slashes inflation forecast, ready to expand QE

The ECB sharply lowered its inflation forecasts for 2015-2017 today and warned that it stands ready to act should downside risks to growth and inflation materialise from recent events i.e. the slowdown in emerging markets ,FX movements. Following its first six-month review of the QE purchase programme (PSPP), the ECB also decided to raise the share limit of bonds it can buy under the programme from 25% to 33%. This flexibility allows the central bank to accelerate the purchase pace or extend the duration of the QE programme if it decided to do so at a later date. The question for the ECB (and the Fed) is whether the impact of recent falls in oil prices and exchange rate movements is transitory or not.

President Draghi comes across as the most dovish we have heard him for a while which frankly is not a complete surprise after the CNY devaluation and falls in equity and commodity markets in recent weeks. The hint at changes to the QE programme and the large inflation forecast revision explain the fall in core yields and receiving in euro IRS, with gains pretty evenly spread across the curve (-4bp). Bigger gains are noted in semi-core and periphery debt with the 10y Bono down over 8bp and Italy down just over 5bp. The 1% fall in EUR/USD is the biggest since the January meeting when QE was launched, and does this clear the path for a return below 1.10? The ball moves back into the court of the USD (NFP tomorrow, FOMC decision on 17 September), and the direction of global stocks (euro negatively correlated).

"The ECB does not rule out inflation falling into negative territory in the coming months as a result of the sharp fall in oil prices. Because of this fall (2016 futures $53.5 vs June ECB forecast of $71 for next year), the ECB lowered its staff CPI forecast for 2015 from 0.3% to 0.1%, for 2016 from 1.5% to 1.1% and for 2017 from 1.8% to 1.7%. The cumulative revision of 0.7ppts is the largest since March. Because of the slowdown in emerging market growth and heightened financial market volatility, the ECB lowered its GDP growth forecast for 2015 from 1.5% to 1.4%, for 2016 from 1.9% to 1.7%, and for 2017 from 2.0% to 1.8",notes Societe Generale.