Notes

Event Trader: ECB Preview
12/7/2016, 1:30:08 PM ET

The European Central Bank is set to announce its latest decision tomorrow morning at 7:45am ET with a press conference from Mario Draghi to follow at 8:30am. Interest rates are expected to remain steady. It is the updated staff projections and comments around the bond purchase program which will garner the most attention tomorrow. We are going to take a quick look at what to expect.

Euro

The single currency has been moving higher ahead of the announcement. There are three factors at play here.
The 1.05 area is setting up as a legit level of support. It held in March of 2015, December 2015, and now the past two weeks.
Mr. Draghi is expected to extend the length of the current bond purchase but there are expectations that he will also look to signal an eventual end or tapering to the program.
The third idea carries a little less weight but investors with along memory will look back at the December 2015 meeting. Recall investors were looking for a big influx of new stimulus from Mr. Draghi. He did not produce (at least against the lofty expectations) and the euro ripped higher. The ECB cut by 10 bps to -0.30% and extended its bond purchase program six months to the current March 2017.
If Draghi does strike a hawkish tone I think we could see more of the post-election losses recovered. The euro basically went straight down from a spike to 1.13 to the 1.05 level. A hawkish Draghi could see an aggressive rally to recover these gains with the 50s-am (1.0895) firmly on the radar.

Projections

The ECB will publish its updated projections which will include 2019 for the first time. These projections include GDP and Inflation and will help formulate opinions on how long the ECB plans on buying bonds. The idea being that, if it projects a pick up in inflation in say Q4 2017 then it may look to taper to combat that pricing pressure.
Like the Fed, The projections are published four times a year: in March and September, when they are produced by ECB staff members; in June and December, when they are produced jointly by euro area national central banks and ECB staff members.
The September Projections for 2016-18 were:
Real GDP is expected to grow by 1.7% in 2016 and by 1.6% in 2017 and 2018.
HICP inflation is expected to average 0.2% in 2016, strongly dampened by a negative contribution from HICP energy inflation related to the past sharp fall in oil prices. As this effect unwinds in early 2017, HICP inflation is expected to increase substantially to 1.2% in that year. The ongoing economic recovery and decline in economic slack are expected to gradually push HICP inflation excluding energy and food higher over the projection horizon, which should support a further increase in headline inflation to 1.6% in 2018.

Bond Purchase Program

As we noted, the expectations are for Mr. Draghi to extend the current time frame which currently sits at 'March 2017 or Beyond'. One would think that the 'or beyond' would cover an extension but the markets like clear set dates. The majority of market participants are expecting another six month extension.
Current expectations are also for the tapering to begin some time in 3Q17.
The monthly size will also be a hotly watched item. It currently is EUR 80 bln (on average) per month. The past argument has been that the ECB is running out of bonds to buy as it must purchase debt that has an interest rate higher than it's current -0.40%. The recent rout in global bonds has helped push yields higher and given a little more levity. There are still expectations that the central bank will increase the amount of one issuance it can hold in order to provide it with more inventory to buy.
Economists are expecting the bank to raise the maximum share of any single public-sector security or exposure to its issuers, that euro area banks can hold. It could also scrap the yield threshold.
There is some belief that Draghi will try to hit a middle ground and extend the asset purchase program while lowering the monthly amounts.

Italy Referendum

This will obviously be a hot topic in Q&A as it is the story of the moment and Mario Draghi's motherland. Mr. Draghi's comments in the past have suggested the ECB is willing to review its current banking policies which carry an unfavorable bail in. The majority of Italian bank debt is owned by retail investors and forcing them to convert their presumably safe bonds into common would not go over well. Spain did a bad bank set up and Mr. Draghi has noted that in the past. This has been a positive for Italian banks and helped provide support.
From his November 3 ECB presser: Improving allocation also requires a well-functioning financial system that can direct funds to dynamic firms. Adequate institutional and judicial frameworks, such as bankruptcy laws and the ability of banks to enforce collateral arrangements, are also needed to ensure capital is not trapped in unproductive or failed firms. The steps taken here in Spain to reduce the legacy effects of the banking crisis will help invigorate the flow of new credit towards profitable and growing firms.

Recent Draghi Comments

On the economy: The euro area economy continues to expand at a moderate, but steady, pace and labour markets are gradually improving, including notably here in Spain. This gradual upward trend is expected to continue, not least owing to our monetary policy measures. But productivity growth has remained very subdued... EVENT Commentary: I would not look for this to change too much.
On fiscal stimulus: Structural reforms are therefore urgently needed to raise productivity growth and unlock unused labour potential and thereby avoid stagnation in per capita income... EVENT Commentary: Again, this will continue as he presses for fiscal stimulus to take the place of the 'only game in town'.
On Monetary Policy: But what about monetary policy? As it turns out, the literature says little about how monetary policy drives the reform process. One view is that an accommodative monetary policy stance may increase the room for manoeuvre of governments, allowing measures to offset some of the short-term costs of reforms. But there are certainly some commentators who at present believe that the ECB's unconventional measures are stifling incentives for reform. To answer this question, preliminary internal research at the ECB investigates the drivers of structural reform in 40 OECD countries over the past three decades. This research supports previous findings in the literature on the drivers of reform. On monetary policy, it finds that lower interest rates, if at all, tend to support rather than hinder the implementation of reforms. We also see this confirmed by anecdotal evidence in some larger euro area countries, which recently implemented some important labour market reforms... EVENT Commentary: This could be the most interesting aspect of the call. If he shows signs of saying that the impact from monetary has dwindled and we need more on the fiscal side, it could be a sign that he is prepared to pull the rug out from under politicians feet and force them into action.