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 Wednesday 20 July 2016

PM Bulletin: ECB look-ahead

 

 

The governing council of the European Central Bank (ECB) meets tomorrow in Frankfurt to discuss monetary policy and interest rates. The central bank is expected to hold its Minimum Bid Rate unchanged at 0% where it has been since March this year. It is also expected to keep its Deposit Rate unchanged at -0.4%. This is the rate that financial institutions are charged to keep surplus funds lodged with the ECB. The central bank first adopted a negative Deposit Rate back in June 2014 when it took it down to -0.10%. This was in an effort to dissuade banks and other institutions from hoarding their cash at the central bank and to persuade them to lend to the wider economy instead.

The ECB is also expected to follow in the Bank of England’s (BoE) footsteps and hold off from further monetary stimulus for now – despite the additional uncertainties unleashed by the UK’s decision to leave the European Union. However, in the same way that the BoE signalled that it was preparing to loosen monetary policy further in August, the ECB looks likely to indicate that more stimulus will be considered at its next meeting in September.

But as far as the ECB’s bond purchase programme is concerned, there are worries that the central bank is running out of qualifying bonds to buy. This is because bonds that yield less than the Deposit Rate are ineligible for the bank’s bond purchase programme. Bond yields were already near record lows prior to the UK’s EU referendum. But the Brexit vote has sent yields even lower. This has led to around 55% of German bonds targeted by the ECB now being ineligible – up from 38% in early June. So it could be that the ECB widens the scope of its bond purchase programme to include riskier assets – for instance holding a bigger percentage of bonds from troubled peripheral countries such as Spain, Portugal, Ireland and Italy, or changing the rules on eligibility. While such tinkering may seem rather technical, any move will have consequences.

But even if the ECB holds off from announcing further monetary stimulus tomorrow, investors will still have to pay close attention to Mario Draghi’s subsequent press conference. Mr Draghi is expected to address concerns over continued tepid Euro zone economic growth and persistent deflation fears. The Euro zone still faces numerous difficulties, not least across the currency zone’s banking sector. We should expect Mr Draghi to be quizzed over the ECB’s response to the ongoing Italian banking crisis and it will be interesting to hear how he responds. Italian banks have around €360 billion of non-performing loans. EU rules now say that bondholders have to take a hit before a Euro zone country can use taxpayer funds to bail out troubled banks. This is potentially disastrous for Italian premier Matteo Renzi as a significant proportion of bank bondholders are private individuals and small businesses rather than financial institutions.

Mr Draghi has form when it comes to jawboning rather than taking direct action. In large part this is due to some members of the ECB’s governing council (led by Bundesbank President Jens Weidmann) who are known to be unhappy with the central bank travelling too far down the rabbit hole of unconventional monetary policy. So perhaps it’s to Mr Draghi’s credit that he has not only managed to push through the ECB’s own version of quantitative easing but also managed to extend the duration of the €80 billion monthly bond purchase programme on a couple of occasions. But the whole complexion of Europe has changed since the Brexit vote. It could be that this means that the governing council becomes more amenable to the prospect of further unconventional monetary policy. If so, then we can expect the euro to struggle to make much headway over the coming months.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin PM

Category: AM Bulletin


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