1. No Change in the ECB’s Deposit Rate

As expected, the ECB (European Central Bank) left the deposit rate unchanged at -0.40%, whilst keeping the refinancing rate also unchanged at 0%. Pretty much everyone in the markets had expected that both rates would be left unchanged, so no real surprise here.

2. Has the ECB Effectively Started “Soft Tapering”

The ECB has committed to keeping the current rate of purchasing €80bn per month for another 3 months to end-March. Then, the purchase amount falls to €60bn for another nine months to end-December 2017. Interestingly, the ECB also says that it may increase the size or duration of their Quantitative Easing (“QE”) bond-buying programme “if necessary”. Other changes announced by Mr. Draghi included the reduction of the minimum purchase maturity from 2 years to 1 year, and perhaps more importantly, that the ECB can, if necessary, buy bonds that yield less than the -0.40% deposit rate. It would appear that the decision to reduce the monthly purchases was not unanimous – Draghi used the phrase “very broad consensus” to describe the decision today. Given the strength of recent economic data and with both headline inflation and forward-looking inflation expectations having moved higher, there were probably members of the Governing Council who were pushing for a more aggressive reduction of the QE programme. But equally, there were likely to be other members of the Council who wanted to extend the QE programme. It looks like ECB President Mario Draghi has managed to find something in his Christmas stocking for everyone on the Governing Council.

3. The Difference Between the “Stock” and the “Flow”

We probably need to make a distinction between the “stock” of bonds held by the ECB and the “flow” of bonds being bought by the Central Banks. Our suspicion is that the ECB is more interested in the stock of bonds – in other words the total amount of bonds that is being bought. As announced today, from March 2017 they will buy a total of €540bn over 9 months (€60bn per month) up to year-end, while under the previous regime, the ECB would have bought a total of just €480bn over 6 months (€80bn per month). They will also reinvest maturing bonds on top of the monthly purchases, as expected.

However, the market, being a bit more short-term, tends to focus on the actual amount being bought every month, and after March this falls to €60bn. This probably explains why the ECB will consider that they have extended their QE programme, but the market will consider that the ECB have started tapering.

4. Slight Revision to Growth and Inflation Forecasts

The growth forecasts for coming years are broadly unchanged – 2017 GDP is seen at 1.7% (1.6% previously); 2018 GDP is seen at 1.6% (unchanged) and 2019 GDP is forecast for the first time to be 1.6%. In the press conference, Draghi continued to point to “downside risks” to growth. Inflation forecasts were also relatively unchanged – 2017 inflation is forecast at 1.3% (vs 1.2% previously); 2018 inflation should average 1.5% (versus 1.6% previously) and 2019 inflation should rise to 1.7%. But Draghi also pointed out that there were “no signs of a convincing upward trend in core inflation”, which suggests that the Council remain concerned about the lack of inflationary pressures. Indeed, at the press conference, Draghi noted that a 1.7% inflation rate in 2019 wasn’t really meeting the ECB’s goal.

5. Overall – A Slightly More Hawkish Tone Than Expected by Markets

Most market participants had expected a continuation of the status quo – €80bn per month for another 6 months. This “soft taper” also hints at a compromise on the ECB Governing Council, although Mr Draghi noted at the press conference that there had been no discussion of tapering at today’s meeting – he described tapering as being a continuous reduction of purchases. Short-dated German bonds have rallied on today’s news and the yield curve has steepened with medium and long-dated bonds under-performing. Peripheral bond markets are performing broadly in line with core markets. The Euro has depreciated by about 1c from pre-meeting levels. The news should also be good for financial bonds and equities, due to the steeper yield curve.