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ECB surprises with commitment to open-ended quantitative easing

The European Central Bank delivered an even more dovish policy package than had been expected Sept. 12, committing to open-ended quantitative easing in a bid to jerk the eurozone out of low inflation and low growth.

The central bank announcement that it would maintain quantitative easing "for as long as necessary" and would only end "shortly before" the central bank starts rate hiking once more. As it is, a rate hike looks a long way off, with the bank also cutting the deposit rate by 10 basis points to -0.50%.

The package was long trailed as inflation continued to fall short of the bank's medium-term 2% target and economic indicators suggest a more protracted weakness in the euro area economy.

"You remember me saying that all instruments were on the table to use. Well, today we did it," said ECB President Mario Draghi at a press conference after the announcement.

The euro dropped as much as 0.75% against the dollar following the bank's announcement, before trading 0.1% higher at $1.1026 at about 10 a.m. ET.

Yields on the continent's sovereign debt fell across the board, as investors absorbed the prospect of perpetual quantitative easing, as appears to be the case in Japan. The sharpest movement was in Italy, where yields on Italian 10-year bonds were down 11 basis points to 0.86%.

"While both the deposit cut and the amount of monthly purchases fall short of market expectations, this is more than outweighed by the changes to the forward guidance and open-endedness of the measures," said Rosie McMellin, fixed income portfolio manager, Fidelity International.

Draghi emphasized that the ECB believes the package "is adequate to reanchor inflation expectations," but repeatedly hit out at the lack of fiscal support which has been a long standing gripe of Draghi's.

"Governments with fiscal space should act in an effective and timely manner ... it's high time for the fiscal policy to take charge," Draghi said.

Weaker economic outlook

The bank's update of its economic outlook made for grisly reading. Growth forecasts for 2019 and 2020 were downgraded to 1.1% in 2019, 1.2% in 2020, down from 1.2% and 1.4% in the bank's June projections.

The eurozone industrial sector remains in poor shape, with production slipping by 0.4% in July following a monthly drop of 1.4% in June. Germany, the engine room of European industry, continued to act as a major weight on the sector with activity down 0.8% on month and 5.4% year on year in July.

Inflation also continues to disappoint. The HICP flash estimate Inflation was 1% in August, unchanged from July as higher food inflation offset lower energy prices and the bank downgraded its outlook for 2019 and 2020 to 1.2% and 1%, respectively — down from 1.3% and 1.4% in June.

The bank's headline response was to restart monthly asset purchases from Nov. 1, having previously ended the program at the end of 2018. At €20 billion, the scale of the purchases are smaller than some had expected — and a long way from the peak of €80 billion a month in 2016 — but the commitment to open-ended QE is key, according to Silvia Dall'Angelo, senior economist at Hermes Investment Management.

"While the monthly size of net purchases is modest compared to previous QE rounds, the open-ended nature of the new programme makes it quite powerful," Dall'Angelo said.

ECB introduces tiering

In other moves, the ECB introduced a tiered system of reserve remuneration. In an effort to reduce the impact of negative rates on bank profitability.

"With banks holding around €1.86 trillion of excess reverses at the ECB, the direct cost to the banking industry of the 10bps deposit rate cut, without tiering, amounts to €1.86 billion per year," McMellin said.

The ECB also adjusted the TLTRO III program unveiled in March, reducing the lowest rate achievable for banks from 10 basis points above the deposit rate, to the deposit rate, while the maturity was extended from two years to three.

"On first glance this looks like a pretty dovish package," said Andrew Kenningham, chief European economist at Capital Economics. "It remains doubtful, however, that this will do much to reboot the eurozone economy let alone achieve the near-2% inflation target."