ECB Preview: ECB to fulfil the high expectations

On the back of the dovish stance at the ECB meeting in October, economists expect the ECB to deliver an aggressive package of monetary easing measures in December. Specifically, economists expect ECB to cut the deposit rate by 20bp accompanied by a two-tier deposit rate and to keep the door open for further rate cuts. At the same time, economists expect an expansion of QE purchases to EUR75bn per month and believe the ECB will continue the purchases until December 2016 while keeping the open-endedness of the programme, as ending it should still be dependent on a sustainable adjustment in the inflation path. In order to reach the higher monthly purchases, the ECB is expected to expand the eligible assets under the QE programme to include corporate bonds and possibly regional bonds.

Importantly, economists expect the easing to be the end of the easing cycle, although it is believed the ECB will signal it is ready to cut the deposit rate further. This is because economists expect the recovery to gain momentum in 2016, implying the unemployment rate should approach its structural level and eventually put upward pressure on inflation. However, euro appreciation pressure will remain a challenge for the ECB and for inflation to go up.

"We have changed our view and now expect a deposit rate cut of 20bp versus our previous expectation of a 10bp cut. We have changed our view because (1) none of the ECB members have argued that pricing of more than a 10bp deposit cut seems aggressive and most ECB members have supported the willingness to act strongly at the December meeting, (2) a Reuters article claiming the ECB is considering a two-tiered deposit rate system suggests the ECB is considering a larger deposit rate cut and (3) before these changes, we had already seen the risk as skewed towards the ECB cutting more aggressively in an attempt to send a strong signal of commitment to comply with its inflation mandate", says Danske Bank.

"We expect a 20bp deposit rate cut to be accompanied by a two-tier deposit rate system, with banks charged a different deposit rate depending on the level of excess liquidity deposited with the ECB. The benefit of such a system would be that banks' profitability would be hurt less by the more negative deposit rate as some of the liquidity would be placed at a higher deposit rate. Moreover, the risk of cash hoarding would be less, as the risk of banks passing on the negative rate to retail customers is lower when banks' costs are lower. Denmark, where certificates of deposit are at -75bp, has a twotiered deposit rate system. "added Danske Bank.