The long awaited ECB announcement on changes to its bond purchase (quantitative easing) scheme came yesterday. In most respects it very much met market expectations for a reduction in the monthly purchase amounts and a lengthening of the timetable. Bear in mind this means they are still increasing the ‘stock’ of QE which most people, including the ECB, believe is the important dynamic. From the bond market’s perspective, the flow of purchases and maturities is also very important in the short term since it can be a big driver of supply and demand and therefore bond prices.
Turning to the detail of the changes the ECB will, from January, reduce its monthly government bond purchases from $60bn per month to €30bn. Since June 2016 they have on average purchased a total of circa €71.8bn per month of government and non-financial corporate bonds. The program will continue until at least September 2018 and won’t end before its inflation aims are met (a sustainable return of CPI close to 2%).
A point that ECB governor Draghi was keen to emphasise was that the proceeds of the program’s maturing bonds would be reinvested for an extended period after ending. The key here is that as the stock of bonds has grown this number becomes rather large. Some estimates are in the €15bn to €20bn per month range, meaning that as this kicks in the effect of the reduction in net purchases is diminished by the need to reinvest across the maturity spectrum. As markets took the implications on board there was actually a modest rally in European government bonds and a fall in the euro. These effects were also promoted by Draghi’s reiteration of the council’s observation that underlying inflation measures have yet to show a convincing uptrend, that continuing monetary support remains necessary and there is no set end date to the QE program. He also repeated the regular statement that rates would stay where they are until at least the end of the QE program. Markets lowered slightly their interest rate expectations and are not currently expecting any rate increase until well into 2019.
Overall though, the council’s fundamental view was of increasingly robust growth in the eurozone economy and this justified the ‘recalibration’ of policy. One should realise that this ‘recalibration’, though fully expected, will have the effect of further stimulating the eurozone economy which many believe is already running above its potential growth rate.
The ECB is trying to join the small club of central banks on the path to policy normalisation but is wary of upsetting the growth outlook and asset markets. If the global growth outlook remains favourable and inflation starts to rise again next year we believe interest rate expectations and bond yields have the potential to rise a lot higher in Europe. In the meantime we may see further euro/US dollar weakness as further divergence of US and EU monetary policy cycles favour the dollar.