Daily Commentary BY THE CURVE TEAM –

Monetary Policy Divergence Set to Widen Further

15th of June, 2018

Last night the ECB announced they will follow in the US Federal Reserve’s footsteps and call an end to its Quantitative Easing Program. The big news though is what was said about the cash rate which more closely resembles the RBA outlook rather than the Fed’s.

At their monthly board meeting, the ECB overnight announced that they would draw to a close their quantitative easing program by year’s end. As opposed to the Fed who are actively running down their balance sheet in what has been deemed quantitative tightening, the ECB’s first step will be to cease net purchases.

The ECB will continue to reinvest maturities “as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation”. This move is straight from the Fed’s playbook, as they used a similar strategy before moving on to normalising monetary policy through higher rates and shirking their balance sheet.

While the move away from quantitative easing was widely expected, the update to the interest rate outlook caught the market by surprise. The ECB stated that they expect the current level of interest rates to remain at current levels “through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with our current expectations of a sustained adjustment path”.

The ECB’s interest rate outlook is very similar to that of the RBA’s and confirmed that the divergence between policy outlook’s with the Fed is expected to widen further over the year ahead. We could see another three and maybe four tightenings from the Fed by the middle of next year.

While the ECB may not look to raise rates before then, current market pricing doesn’t see the RBA lifting rates until further out. Market pricing has slipped further since the Governors speech on Wednesday and is barely clinging to a November 2019 hike. It is looking increasingly likely that we may not see any change in the cash rate until 2020.

David Flanagan

Director - Interest Rate Markets