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Investment Research — General Market Conditions
4 November 2014
ECB preview
Waiting for the impact of the easing measures
We expect the ECB to remain in wait-and-see mode at the meeting in November and we
believe the tone will be more dovish compared to the latest meeting in October, when
Mario Draghi signalled that QE in sovereign bonds is not just around the corner, see ECB
meeting: QE in sovereign bonds not just around the corner, 2 October 2014.
The dovish stance should follow as the pressure on the ECB increased during October:
actual inflation has only increased slightly despite significant base effects from last year’s
decline, inflation expectations have declined further, growth momentum has weakened
and market turmoil has been a concern (see more below). We believe Draghi will be less
defensive and will thus be interpreted as more dovish, although the ECB is still waiting
for the economic impact of the measures announced in June and September.
Draghi is likely to put a lot of focus on the Covered Bond Purchase Programme (CBPP)
at the meeting on Thursday. The ECB has so far conducted secondary market purchases
of EUR4.8bn in just eight trading days and has thus maintained a high run-rate
throughout the period. This should give the CBPP programme credibility and hence be
positive for the markets while it buys Draghi some more time .
Overall it is our expectation that the ECB will keep its powder dry, even though there are
arguments for more easing. In terms of policy rates, Draghi has repeated that the ECB has
reached the lower bound on rates and technical adjustments should no longer be possible
after the latest cut in September.
Concerning non-standard measures aimed at boosting the balance sheet, we expect the
ECB to remain in wait-and-see mode at least until it has the results of December’s
TLTRO auction. The Governing Council seems determined to obtain a sizeable impact on
the balance sheet in order to get inflation back at 2% but there is still an element of
‘passive provision’ in the monetary policy, as the TLTRO depends on banks’ demand for
liquidity.
Regarding QE in sovereign bonds, there is a clear opposition from the Bundesbank and in
our view the fact that the ECB introduced negative rates and dug deep into the toolbox of
unconventional measures suggests that the bar for broad-based QE is high and that some
members doubt the effectiveness of this. Draghi has also said that QE is most effective if
it is concentrated on activities close to the credit easing components of the financial assets
and because of that the ECB now starts buying ABS.
Instead of going down the QE path, the ECB could start buying corporate bonds. Such a
move would have a positive market impact, as it would show that the ECB is determined
to boost its balance sheet.
The market focuses on how far the discussion on expanding the QE programme to other
assets has come. Still, it would be a surprise if the ECB already announces new measures
Senior Analyst
Pernille Bomholdt Nielsen
+45 45 13 20 21
[email protected]
Senior Analyst
Lars Tranberg Rasmussen
+45 45 12 85 18
[email protected]
Important disclosures and certifications are contained from page 6 of this report.
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ECB preview
this week. As our expectation is that Draghi will aim for a soft tone, we believe his tone
will not be that far from the market pricing, i.e. he will keep expectations alive that the
ECB can do more – for instance, buy more assets. In the light of the weak growth data,
the low inflation and a soft ECB but no action, we believe there is still value in being long
Bunds ahead of New Year. Regarding the recent price action in the periphery markets, it
is notable that it has not taken much to move the market in either direction and Thursday
is likely to be no different in that respect. The high volatility is likely to prevail going into
year-end.
A number of headaches for Draghi

Euro inflation only increased to 0.4% y/y in October from 0.3% y/y in
September. In October base effects should have supported inflation and given the
ECB some relief but the low figure will likely imply that the ECB has to revise its
inflation projection lower in December, see Euro inflation slightly higher but more
pressure on the ECB, 31 October 2014. Moreover, inflation has now been in Draghi’s
previous definition of a ‘danger zone’ (below 1%) for 13 consecutive months.
How the ECB sees it. The ECB expected inflation to pick up in Q4 as its latest
projection from September implied an increase in inflation to 0.75% in Q4 from 0.4%
in Q3 and the small increase in October is likely to be a disappointment. However, the
ECB is waiting for the impact of its latest monetary easing, which according to
Draghi should be seen 9-12 months after it eased.

5y5y inflation expectations have continued to decline after the ECB eased in
September and are currently around 1.83%. When the medium-term expectations
declined below 2% in August, Draghi expressed concern and afterwards the ECB
eased monetary policy further by cutting rates and introducing its CBPP3 and ABS
purchases in September.
How the ECB sees it. The decline in inflation expectations gives Draghi a headache
but in October he downplayed the role of the 5y5y inflation expectations as he said
‘we use a broad range of indicators’. In light of this it is interesting that the ECB will
get new information from the Survey of Professional Forecasters at the meeting in
November. Last quarter it increased marginally but any sign of de-anchoring will
increase the pressure on the ECB further.

The oil price has continued lower and consequently there was a monthly decline in
energy prices in the euro area of 0.7% in October. This is a concern for the ECB as it
continues to put downside pressure on headline inflation.
How the ECB sees it. The ECB will probably continue to argue that low inflation is
mainly the result of the significant drop in the oil price. However, in October last
year, the ECB wrote that ‘longer-lasting supply shocks may have a systematic impact
on inflation and could affect inflation expectations, meaning that monetary policy
should respond to them’. This seems to be the case, but we believe the ECB will argue
that it has already eased monetary policy in response to supply shocks.

Wage growth has declined to the lowest rate of increase in 16 years. Hence there
are signs of ‘second round effects’, where workers become satisfied with lower wage
increases as inflation is low. If this continues core inflation can go even lower and this
is a significant risk for the ECB although real wage growth is the highest since 2010.
How the ECB sees it. The low wage growth is something the ECB is concerned about
but the latest figure for Q2 was released ahead of the October ECB meeting where it
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was not enough to trigger more easing. Again, the ECB is likely to argue that it is
waiting for the economic impact from its already announced easing measures.

Activity data are weak. The growth momentum continued to look weak during
October and regarding the PMIs, the composite new orders index fell further in
October. In addition, the latest PMIs caused some concern that there was a sharp
deterioration in the order-inventory balance within euro manufacturing. This points to
further weakness in manufacturing as companies need to work off too high inventory
levels, see Euro PMI still trending lower, 23 October 2014
How the ECB sees it. Draghi usually focuses on PMIs and he has several times
mentioned the loss of momentum in activity. However, he has also called for fiscal
easing and a coherent strategy for a sustainable recovery and argued that ‘there is
room for fiscal strategies to better exploit the existing scope for a more growthfriendly composition of fiscal policies’.

Recent market turmoil. In the middle of October the risk-off sentiment escalated
markedly and peripheral bond spreads widened significantly after European stocks
had traded weakly for a while. When the market rumbles the market turns to
policymakers for relief but the ECB has not given support.
How the ECB sees it. Draghi was scheduled to speak when the market turmoil was at
its highest but nothing was released and the absence of comments was a
disappointment. In general, the ECB usually reacts slowly and since things have
calmed down again, this should not get most attention at the ECB meeting.

The ECB has finalised its comprehensive assessment and it appeared that the
capital shortfalls were smaller than feared. Consequently, shortage of bank capital
should be less of a headwind for credit creation and economic activity going forward.
How the ECB sees it. The ECB is likely to wait and see whether the supply of credit
can increase further next year after the asset quality review and stress tests are out of
the way. In light of this, the ECB might argue that the demand for credit is now
crucial for credit growth to pick up and that there is a need for a fiscal policy in order
to stimulate domestic demand.
Inflation in the ‘danger zone’ for 13 consecutive months
The ECB will revise its inflation projection lower in December
Source: ECB, Eurostat, Danske Bank Markets
Source: ECB, Eurostat, Danske Bank Markets
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5Y5Y inflation expectations declined further in October
Survey of Professional Forecasters’ inflation expectations
due for release
Source: ECB, Macrobond, Danske Bank Markets
Source: ECB
The oil price has continued lower - downside pressure on
inflation
Signs of 'second round effects' in wage growth
Source: Macrobond, Danske Bank Markets
Source: ECB, Danske Bank Markets
PMIs show a loss of momentum in activity
Deterioration in order-inventory balance a concern
Source: Macrobond, Danske Bank Markets
Source: Macrobond, Danske Bank Markets
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Shortage of bank capital should be a smaller headwind
Banks are easing credit standards
Source: ECB, Danske Bank Markets
Source: Danske Bank Markets
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Disclosure
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske
Bank’). The authors of the research report are Pernille Bomholdt Nielsen and Lars Tranberg Rasmussen.
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