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Confused About What Mario Draghi Will Do Next? Here's The Official Decision Tree From His Former Employer

Earlier today, after a disappointingly un-uber-dovish speech by Draghi, it appeared The ECB needed to double down on the easing message to make sure 'markets' believe. As we noted, EURUSD tumbled 50 pips - to the lows of the day - after Reuters report that the central banks is mulling buying the debt of cities and regions.

The punchline was this: "Some cities in Spain or Italy are bust. But a city will always be there. Someone will always pay back the debt. They have the backing of the government and the ability to raise taxes."

In that case, Chicago seems like it might be a good place to invest. After all, PIMCO sees “long-term” value in the city’s junk. We suppose it's the same "someone will always pay it back" logic.

This comes just as reports suggest that depending on DBRS, the ECB could cut Portugal off from QE even as Draghi buys munis.

Or, as we suggested to the ECB on Twitter (where the central bank used to follow us before a social media intern got a tap on the shoulder): 


here is the "to buy next" list:
- Copper
- Zinc
- Porcelain bidets
- Lumber
- 1952 Topps Mickey Mantle cards
- Brent

— zerohedge (@zerohedge)

Anyway, the market needn't have been concerned even for a second about the ECB's easing bias because, i) the EU is in a deflationary spiral which means the central bank needs to do something else to avoid having to explain how NIRP and €1.1 trillion in QE could possibly result in a disinflationary impulse, and ii) Mario Draghi's former employer has taken a look at the situation and determined that all roads lead to either a depo rate cut, a PSPP extension, or both. Below, find some color from the blood sucking cephalopod.

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Our base case remains that there will be an announcement of a prolongation of the ECB’s Asset Purchase Programme (APP) through the end of the third quarter of 2017, implying additional purchases of around €500bn relative to a programme that ends in September 2016 (as Mr. Draghi’s existing formal language suggests).

But the Governing Council may decide to provide further stimulus beyond an extension of the APP. Indeed, several Governing Council members have recently stated that there will be “no taboos”, and Mr. Draghi stressed during the press conference that “the stance of the Governing Council discussion today, one would say was not ‘wait and see’, but it was ‘work and assess’“. In this week’s European Economics Analyst, we discuss potential scenarios under which the Governing Council may decide to ease monetary policy beyond an extension of the purchase programme. While such further easing is possible at the December meeting itself, we develop a framework for considering actions into next year.

Two developments would trigger additional actions from the ECB:

  1. An “unwarranted” tightening of financial conditions. The ECB’s baseline scenario is predicated on monetary policy remaining very accommodative over the forecasting horizon. An increase in yields and/or a strong appreciation of the exchange rate that leads to a significant tightening of financial conditions would place the ECB’s baseline scenario at risk, prompting the ECB to react.
  2. A weaker growth and inflation outlook. Even if financial conditions remain as accommodative as the ECB is assuming, growth may nonetheless develop more sluggishly and/or inflation may fail to show the gradual pick-up that the ECB (and we) are forecasting. Such a development would also demand more monetary policy easing.

It is important to stress that the ECB is also willing to react in anticipation of either of these two developments: it should (and will, in our view) maintain an appropriately forwardlooking stance. Hence, the ECB may act even if current data are inconclusive. (This also implies that the Governing Council would act if its members believed that not acting would result in a market response that would lead to tighter financial conditions.) 

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Essentially then, this is a foregone conclusion, the only question is now that there are "no taboos," and assuming they don't take our advice on the '52 Mantles, is whether they will pair a depo rate cut with the PSPP expansion (in whatever form it takes). Presented below is Goldman's ECB decision tree which may (or may not) help you decipher what combination of events could help to shape Lloyd Blankfein's Mario Draghi's decision: