Euro Bond Markets Brace for Rally Ahead of Policy Tightening
AFP 2017/ DANIEL ROLANDBusiness13:51 22.10.2017(updated 13:52 22.10.2017) Get short URL
The European Central Bank (ECB) plans to reduce its bond purchases by at least 20 billion euros per month, likely driving up market demand for safe havens, hindering volatility and non-financial investment, hindering the Eurozone’s overall economic expansion.
Kristian Rouz – The European Central Bank (ECB) is poised to start wrapping up its unconventional monetary stimulus as early as this coming week. Policy tightening, albeit extremely gradual, will affect the common currency and bond valuations across the bloc. With access to borrowing slightly restricted, GDP growth across all euro economies is likely to slow, whilst overall economic sustainability is expected to improve.
ECB chief Mario Draghi says Thursday’s meeting of the central bank policy board will decrease the scale of the regulator’s monthly bond-buying program, whilst the regime of negative and zero-interest rates (ZIRP and NIRP) will remain in place for roughly two more years.
This would make the ECB’s era of unconventional monetary stimulus the second-longest in history – next to the Bank of Japan’s (BOJ). However, Draghi also urged economy ministers from member-countries to promote reforms aimed at greater openness and open market-orientated competitiveness – in order to soften the challenges to growth posed by the tightening monetary environment.
The ECB is currently buying 60 billion euros-worth of bonds per month and the pace of central bank bond-buying will decrease. Complimentary fiscal policy measures would also help, but the Eurozone is lacking a coordinated fiscal policy across its member-states. That said, each nation will react to changes in the single monetary policy as deemed appropriate. This could create greater economic imbalances within the bloc, and a renewed struggle for intra-Eurozone competitiveness.
The ECB is expected to downscale its monthly bond purchases to 40 billion euros at its policy meeting on October 26th.
“For example, 20 billion euros per month would imply that QE could immediately end once the extension is complete. In contrast, 40 billion euros per month is far more likely to require a further taper,” Citibank said in a note.
Citi analysts expect a strong market reaction to the ECB’s tapering of its accommodative measures, with the 10-year Deutsche Bund yield easing as much as 0.25 percent, reflecting the increase in the note’s value. The 10-year Bund yield would thus retreat to 0.70 percent, its 2015 level.
Lower bond yields suggest overall market volatility will decline, spurring demand for assets, and draining the non-financial sector, as well as, stock markets, of investment capital. This could entail negative consequences for overall economic expansion.
The Eurozone’s economy grew by 2.3 percent in Q2, compared to 1.5 percent in the UK, which is nearing its first interest rate hike in over a decade due to rapid inflation.
However, Citi analysts point out, in case of a more hawkish tapering in ECB bond purchases, the 10-year Bund yield could rise by 0.15-0.20 percent, reflecting a sell-off in debt securities, and spurring fixed investment in non-financial sector and stocks. This could actually bolster the Eurozone’s economy in the near-term.
Besides, the ECB is facing increased pressure to crackdown on non-performing loans (NPL), in order to stave off possible risks to the stability of the European banking system. The ECB’s Single Supervisory Mechanism (SSM) observed that NPLs are still on the rise, following Italy’s banking problems of late 2016-early 2017.
The regulator said commercial banks should set aside part of their own capital (in the form of non-binding reserve-ratio requirement, RRR), in order to have resources for extinguishing any looming issues stemming from their NPL inventory.
Currently, the total amount of the Eurozone’s NPLs is estimated at $1.trillion.
However, undercapitalized Italian banks are objecting to such ECB recommendations.
Nonetheless, the stiffening of central bank monetary policies looming large on the horizon will challenge commercial banks’ ability to address the emerging risks by increasing their own borrowing from the ECB. Despite the low scale of planned ECB policy tightening, it is already stirring significant market anxiety, meaning the coming week will be a volatile period for the Eurozone stocks, the euro, and non-financial investments.