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ECB may calibrate forward guidance in pursuit of greater stimulus - RBS

FXStreet (Łódź) - Richard Barwell, Senior European Economist at RBS, looks at ECB's current forward guidance on rates and the balance sheet and speculates on the possible future innovations.

Key quotes

"The Governing Council is now providing guidance about the stance of monetary policy in three dimensions – the price of central bank money, the quantity of central bank money and time."

"There is every chance that the Governing Council may want to inject further stimulus into the economy at the December or March meetings given the inexorable – and largely inexplicable – decline in breakeven inflation but purchases of government bonds may remain contentious."

"The Council may therefore be on the lookout for alternative means of injecting stimulus into the economy, and that is where the calibration of the forward guidance in all three dimensions comes back on the agenda. In particular, we consider the following innovations:"

"The return of fixed rate forward guidance (FRFG): the signal that rates will not rise over the lifetime of the TLTROs (rates on hold for four years)."

"An Odyssean commitment to a history dependent strategy: guidance that rates will remain low for too long …. in the sense that rates will not rise until a specified fraction of the cumulative shortfall in the level of nominal GDP has been reversed."

"Dual commitments on balance sheet expansion and asset purchases: the Council quantifies how these proxies of the policy stance are expected to evolve, and adjusts those commitments in the light of events."

"Clarity over preferences, with a conditional commitment to purchase sovereign bonds: the Council signals that it attaches more importance to the scale of asset purchases than the mix, and therefore will buy other assets if and only if the current universe of assets proves insufficient."

"Open-ended ('do whatever it takes') guidance on the quantity of money: a high risk QE3 style pledge to keep buying assets until breakeven inflation rates behave themselves."

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