Tanguy Le Saout, head of European Fixed Income at Pioneer Investments, discusses the measures announced and the market reaction.
As the ECB met for its regular monthly meeting, anticipation was running high that they would announce further measures to help tackle Europe’s twin problems of low growth and falling inflation.
At a conference in August in Jackson Hole, attended by the world’s top central bankers, ECB President Mario Draghi in a surprising move deviated from his prepared speech. He noted that “the ECB’s governing council would use all the available instruments needed to ensure price stability in the near-term” and “the risks of doing too little outweigh those of doing too much”. These unscripted remarks, along with others uttered by Mr Draghi, appeared to signal a significant shift in ECB policy. It raised hopes for the imminent announcement of a Quantitative Easing programme, and caused a substantial fall in European bond yields and the Euro currency.
So, with expectations high, the question was – would Mario Draghi and the ECB deliver?
Well, in our opinion, yes they did. The ECB announced cuts of 10bps to both the main refinancing rate and the deposit rate, bringing the refi rate to 0.05% and the deposit rate falls further into negative territory at -0.20%. This means banks actually have to pay the ECB 20bps to leave money on deposit with the ECB. In the press conference, Mr Draghi noted that the ECB now believe they have reached the “lower bound”, with respect to rates, meaning rates will not be cut further.
Also announced was the start of an asset purchase programme in October 2014, so effectively next month. The ECB will start by purchasing asset-backed securities and covered bonds, and interestingly, the amount of purchases will be open-ended, so the programme has no set target size. The other key point made by Mr Draghi was that if conditions continued to deteriorate, the governing council was prepared to use all available non-conventional monetary policy measures to achieve their inflation targets. So, a commitment to possible further action, but no commitment to use full-blown sovereign Quantitative Easing. Indeed, in the press conference, Mr Draghi admitted that the ECB had discussed sovereign QE but some ECB members were not happy to go that far right now.
The cut in the deposit rate, in our opinion, is a direct attempt to weaken the Euro, and appears to have worked, with the Euro dropping from 1.3150 against the US Dollar to 1.3050 straight after the announcement. This should benefit European exporters and help inflation creep a little higher. Remember – the Euro has now fallen from 1.40 in early May to almost 1.30 now – that, in our view, will be helpful to the Euro economy. This currency movement will help investment strategies that were positioned for a stronger US Dollar.
The announcement of the ABS bond purchase programme, along with the commitment to use other measures, has caused an immediate rally in bond yields, both in core markets and peripheral markets. However, in our opinion, this rally in yields will not last, meaning that a short duration strategy could still outperform.
The measures announced should also help, in our opinion, to boost growth and inflation, particularly in 2015 and 2016. In our view, this should be good for any strategies that are positioned for higher European inflation in the coming years. In this sense, we believe these higher growth and inflation forecasts make it unlikely that full-blown sovereign QE will be enacted, especially as Mr Draghi has signalled that there remains opposition to this option amongst members of the ECB council.
From a credit market point of view, the ECB announcement is, in our opinion, positive and should lead to tighter spreads, particularly in the Financial sector, where banks will be incentivised to borrow in the upcoming Targeted Long Term Rate Operations or TLTRO’s.
To conclude, the measures announced are all positive for the European economy and should help underpin the recovery in economic conditions.
However, we remain of the view that sovereign QE is still very unlikely to be enacted.