ECB towards more easing

Monetary and financial conditions continued to deteriorate in September: the euro has appreciated further on a trade-weighted basis, inflation expectations have remained weak, equity and credit markets have tightened and headline inflation has dropped back into the negative territory. Although the monetary environment remains supportive, the Financial Condition Index has given back the gains recorded since the beginning of 2015 and is now standing at its pre-QE announcement level. These developments are in line with the deterioration of the global economic situation over recent months and add to the downside risk on the European economic outlook and the inflation outlook. 

The decision taken at the September meeting to increase the issue limit of bonds eligible in the PSPP from 25% to 33% could be interpreted as a signal that additional QE measures could be deployed to lean against a revised downward inflation outlook  in order to comply with its mandate to bring inflation below but close to 2% in the medium term, the ECB will need to ease monetary policy further before year-end. A commitment to extend the timeframe of the programme until at least a later date than September 2016 is a serious possibility, and this could be announced as early as in October, to reinforce the forward guidance. 

Should the global economic situation deteriorate more in the coming months, and/or should the euro continue to appreciate, an extension of the size and the scope of asset purchases would be the next option, but it is unlikely to be decided in October.  

As a last resort, it is believed that a cut in the rate of the deposit facility is a possibility. However, this option is probably unlikely to be triggered before year-end as it is still quite controversial, particularly in Germany and France where banks have been complaining that a negative depo rate was undermining their financial position. However, it could probably be deployed during the first quarter of 2016 as long as the Fed does not increase rates in December.