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Macro Weekly

4 March 2016

The ECB’s March package

• We preview the ECB’s meeting next week, which will very likely deliver

monetary stimulus, but there is uncertainty about exactly what it will do

• Our base case is a 20bp deposit rate cut coupled by steps to cushion the

impact on banks such as a tiered rate system…

• …and a new long-term loan facility for banks

• We also expect an increase and extension of QE, which should be

facilitated by removing the deposit rate floor for purchases

• We think further monetary stimulus is justified and will have a positive

effect, though the ECB needs support from other policymakers

Once again all eyes are on the ECB

Next week’s ECB meeting promises to be another big even in the economic and

financial market calendar. The ECB is almost certain to act, but there is uncertainty

about exactly what it will do. At the same time there is increasing scepticism about

the impact of monetary policy. Some argue it is ineffective at best and harmful at

worst, leading to worries that we have reached a limit to what central banks can do to

tackle the increased downside risks to the outlook for growth and inflation. In this

preview, we ask five big ECB questions.

Box: The ECB’s March Package

We expect the following measures:

• A 20bp deposit rate cut to -0.5%

• Introduction of a tiered deposit rate system

• A new long-term loan facility for banks

• A EUR 10bn increase in monthly asset purchases

• Increase in duration of asset purchases to June 2017

• Removal of the deposit rate floor for asset purchases

What will the ECB do?

We think the ECB will announce a broad package of measures next week including

rate cuts, measures to support the banking system and an increase in asset

purchases (see box above). Over the last year or two, the ECB has generally

introduced policies on a number of fronts in an attempt to magnify the impact on

financial conditions and the economy, as well as to create a ‘big statement’ on

Group Economics

Nick Kounis

Head Macro & Financial Markets

Research

Tel: +31 20 343 5616

nick.kounis@nl.abnamro.com

2 Macro Weekly – The ECB’s March package – 4 March 2016

announcement in order to shape expectations. In addition, the deterioration in the

outlook for economic growth – and especially inflation - has been large. For instance,

the ECB’s 2016 inflation forecast will likely come down by around one percentage

point (taking it to zero) while the 2017 forecast may be reduced by 0.3 points to

1.3%. That means a significant response will be needed.

What are markets pricing in?

Interest rate futures look to be pricing in a 10bp reduction at next week’s meeting

(around 12bp is factored in) and a total of 18bp of reductions by June. Expectations

of QE are difficult to decipher from market prices, but surveys of economists and

strategists suggest that a EUR 10bn increase in the pace of monthly asset purchases

to a total of EUR 70bn is seen as most likely (see table below).

ECB policy actions and market expectations

Policy tool Beating expectations Meeting expectations Missing expectations

Deposit rate cut 20bp cut or more 10bp cut No cut

Extension of QE As long as necessary June 2017 March 2017

Monthly purchases EUR 20 bn increase EUR 10bn increase No change

Forward guidanceNot reached lower bound

No guidance on lower bound

Lower bound reached

Source: ABN AMRO Group Economics

Will the ECB deliver?

Yes. Admittedly there is a lot of uncertainty about exactly what the ECB will do, and

the central bank did disappoint in December. However, we think that this time it will

deliver. We think it will cut the deposit rate by more than expected, while we also

think it will strongly signal it is willing to do more if necessary. We think that the more

neutral members of the Governing Council will be more ready this time to swing

behind ECB President Draghi and the other doves and support more aggressive

stimulus. This is because the business surveys have deteriorated significantly, while

core inflation has fallen and has wiped out its previous gains.

Will negative rates do more harm than good?

A more deeply negative deposit rate on bank excess reserves will on balance likely

be positive for the economy if the system is well designed. The experience so far is

encouraging. For instance, in the eurozone, bank lending rates to households and

companies have come down, bank lending has improved modestly and the euro is

weaker than it would otherwise have been. Evidence from Sweden, that has more

negative rates than the eurozone, has seen even more positive trends. Nevertheless,

it is certainly the case that negative rates have an adverse impact on bank profits and

that if that impact is too big it can undermine the bank lending channel and hence the

economy. So it is important that the ECB takes steps to minimise the impact on

banks. That is why we think that a two-tiered deposit rate system is likely. The

system could be designed so that a majority of excess reserves could receive the refi

3 Macro Weekly – The ECB’s March package – 4 March 2016

rate (currently +5bp) and only a fraction of excess reserves (say a third) would face

the negative deposit rate.

The ECB could also take other steps to support the banking system. For instance it

could provide even longer (and possibly cheaper) refi loans for banks. It could also

reduce the loan rate on existing TLTROs.

Has monetary policy reached its limits?

No, we think the ECB still has room for manoeuver. With a tiered system, it could cut

the deposit rate further beyond March. In addition, it can expand QE. At the March

meeting, we expect it to remove the deposit rate floor for asset purchases, so it will

be able to buy government bonds yielding less than the deposit rate. This will

increase the eligible universe it can buy. In addition, it could in the future make

further adjustments to the programme to allow a further step up or extension of QE

(such as dropping the capital key, as a way to allocate purchases, or the issuer limit).

More generally, there is no limit to the amount of money the ECB can produce, and

central banks have proved innovative in the past in thinking up ways to provide

stimulus. For instance, the ECB could be more aggressive in its ABS programme,

buying more risky tranches of the securities (consisting of packages of loans), which

would help banks to take loans off their balance sheets.

We think ECB stimulus has and will continue to have a positive effect on demand and

inflation. Although the economy is still weak and inflation low, this reflects that the

eurozone is facing increasing headwinds. Growth and inflation would likely be lower

still if the ECB had not acted.

Having said that, the ECB does need the help of other policymakers. For instance, an

increase in fiscal stimulus, in the shape of public investment programmes could help

foster a faster cyclical recovery. In addition, structural reforms can help to lift the

long-term growth rate from its meagre levels.

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4 Macro Weekly – The ECB’s March package – 4 March 2016

Main economic/financial forecasts

Key Global Macro Events

Main economic/financial forecasts

GDP growth (%) 2014 2015 2016e 2017e 3M interbank rate 24/02/2016 02/03/2016 +3M +12M 2016e 2017e

United States 2.4 2.4 1.7 2.1 United States 0.63 0.63 0.6 0.6 0.6 1.4

Eurozone 0.9 1.5 1.2 1.6 Eurozone -0.20 -0.21 -0.55 -0.55 -0.55 -0.55

Japan -0.1 0.5 0.8 0.6 Japan 0.10 0.10 -0.1 -0.1 -0.1 -0.1

United Kingdom 2.9 2.2 1.6 2.5 United Kingdom 0.59 0.59 0.6 0.9 0.6 1.6

China 7.3 6.9 6.5 6.0

World 3.4 3.1 3.0 3.5

Inflation (%) 2014 2015 2016e 2017e 10Y interest rate 24/02/2016 02/03/2016 +3M +12M 2016e 2017e

United States 1.6 0.1 1.4 1.6 US Treasury 1.74 1.85 1.9 2.2 2.2 2.5

Eurozone 0.4 0.0 0.1 1.5 German Bund 0.15 0.21 0.2 0.5 0.5 0.8

Japan 2.8 0.8 0.5 1.8 Euro sw ap rate 0.55 0.60 0.5 0.7 0.7 1.0

United Kingdom 1.5 0.0 0.5 1.8 Japanese gov. bonds -0.04 -0.06 0.2 0.3 0.2 0.3

China 2.0 1.4 2.0 2.5 UK gilts 1.36 1.46 1.5 1.7 1.7 2.3

World 3.8 3.6 3.8 3.6

Key policy rate 02/03/2016 +3M 2016e 2017e Currencies 24/02/2016 02/03/2016 +3M +12M 2016e 2017e

Federal Reserve 0.50 0.50 0.50 1.25 EUR/USD 1.10 1.08 1.05 1.05 1.05 1.05

European Central Bank -0.30 -0.70 -0.70 -0.70 USD/JPY 112.2 113.5 117 122 120 120

Bank of Japan -0.10 -0.30 -0.30 -0.30 GBP/USD 1.39 1.41 1.35 1.50 1.48 1.50

Bank of England 0.50 0.50 0.50 1.50 EUR/GBP 0.79 0.77 0.78 0.7 0.71 0.70

People's Bank of China 4.35 4.10 3.85 3.85 USD/CNY 6.54 6.55 6.55 6.75 6.70 6.80

Source: Thomson Reuters Datastream, ABN AMRO Group Economics.

Day Date Time Country Key Economic Indicators and Events Period Latest outcome Consensus ABN AMRO

Monday 07/03/2016 08:00:00 DE Manufacturing orders - % mom Jan -0.7 -0.2 0.0Monday 07/03/2016 09:00:00 CH Foreign currency reserves - CHF mln Feb 574964Monday 07/03/2016 21:00:00 US Fed Reserve consumer credit - USD bn Jan 21.3 15.3

Tuesday 08/03/2016 00:50:00 JP GDP - % qoq 4Q F -0.4 -0.4Tuesday 08/03/2016 08:00:00 DE Industrial production - % mom Jan -1.2 1.4

Tuesday 08/03/2016 11:00:00 EC GDP - % qoq 4Q P 0.3 0.3 0.3Tuesday 08/03/2016 12:00:00 US NFIB small business optimismem - index Feb 93.9 94.2 94.0Tuesday 08/03/2016 CN Exports - % yoy Feb -11.2 -14.5

Tuesday 08/03/2016 CN Imports - % yoy Feb -18.8 -10.1

Wednesday 09/03/2016 16:00:00 CA Policy rate - % Mar 9 0.5 0.5 0.5Wednesday 09/03/2016 NZ Policy rate - % Mar 10 2.5 2.5 2.5

Thursday 10/03/2016 02:30:00 CN CPI - % yoy Feb 1.8 1.9

Thursday 10/03/2016 02:30:00 CN PPI - % yoy Feb -5.3 -4.9Thursday 10/03/2016 06:30:00 NL CPI - % yoy Feb 0.6 0.6Thursday 10/03/2016 13:45:00 EC ECB Deposit rate - % Mar 10 -0.3 -0.4 -0.5Thursday 10/03/2016 13:45:00 EC ECB Refi Rate - % Mar 10 0.05 0.05 0.05Thursday 10/03/2017 14:30:00 EC ECB Press Conference

Thursday 10/03/2016 14:30:00 US Initial jobless claims 278.0 275.0Thursday 10/03/2016 15/03/2016 CN M2 money growth - % yoy Feb 14.0 13.7

Thursday 10/03/2016 15/03/2016 CN New loans - CNY bn Feb 2510 1200

Thursday 10/03/2016 15/03/2016 CN Aggregate financing - CNY bn Feb 3417 1780Thursday 10/03/2016 KR Policy rate - % Mar 10 1.5 1.5 1.5

Friday 11/03/2016 08:00:00 DE CPI - % yoy Feb F 0.0Friday 11/03/2016 10:30:00 GB Trade balance - GDP mln Jan -2709

Friday 11/03/2016 PL Reference rate - % Mar 11 1.5 1.5

Source: Bloomberg, Reuters, ABN AMRO Group Economics (we provide own forecasts only for selected key variables and events)

5 Macro Weekly – The ECB’s March package – 4 March 2016