In our main scenario the ECB takes a significant easing step and surprises markets at the meeting in June. This could very well be the end of the easing cycle as it should lead to higher growth and put upward pressure on inflation.
It will take some time before the impact of the easing is seen and inflation should stay around the current level until Q4 and only drift slowly upward afterwards. In light of this the discussion about further easing can continue for some time.
In case ECB easing remains a topic the discussion will take two stages. In the first phase focus will be on the weak credit growth and if inflation remains below 1% during 2015 focus should shift to a broad-based QE.
We believe the probability of a measure aimed at encouraging bank lending has increased recently, but if the issue is not addressed credit growth could remain low and be the most important figure to watch looking ahead.
Added to this we expect that the June meeting will only mark the end of easing if the impaired transmission mechanism is accommodated so that the monetary easing affects the real economy more efficiently.
Regarding QE we think the bar is very high and that it takes a higher risk of too low inflation than we see coming. Moreover, a new LTRO could result in a boost to the ECB's balance sheet, which should remove some of the pressure for QE.
The short-end of the EUR swap curve will move lower when the ECB announces its measures. In the long-end the initial reaction is lower rates but if the market deems the measures as credible in terms of restoring long-term growth and inflation, then the long end of the curve should eventually move higher.
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