ECB extends QE but cuts size to €60bn, but don’t call it tapering - SocGen

The EUR fell back and the EUR IRS curve bear steepened sharply after the ECB announced a 9m extension of asset purchases from April to December next year notes Research Team at Societe Generale.

Key Quotes

“Inflation in the euro area will not return to target in 2019, but optimism that deflation has been overcome prompted the ECB to reduce monthly purchases next year from €80bn pcm to €60bn pcm. For the ECB, this is not tapering, as President Draghi considers tapering a reduction in purchases to zero, which obviously is not the strategy that was laid out. The market (and the Oxford Dictionary) has a different view, however – cue the steepening in EUR 2y/10y IRS to 98bp, led by the rise in 10y IRS to 0.80% but fall in 2y IRS to -0.175%.” 

“The retreat of the EUR is explained in large part by the changed modalities of the Asset Purchase Programme (APP) and subsequent widening in shorter-dated UST/Bund spreads. The 5y UST/Bund spread, for example, widened 13bp at the intra-day high, as the ECB announced that it will now buy securities with a maturity as short as 1y (vs 2y previously). Securities with a yield below the ECB deposit rate (-0.40%) will now also qualify; this was not the case before.”

“The open-ended nature of future asset purchases beyond December 2017 is also dovish, as it gives the central bank the scope to increase the size and duration of bond purchases again from €60bn pcm should economic or financial conditions worsen again and the return of inflation towards the target suffer further delay. The open-ended nature also stems from the fact that the ECB still has doubts that the upturn in inflation thanks to base effects will become entrenched. Though it is confident that the battle against deflation has been won, it does not forecast a return of inflation in the euro area to the target of close to but below 2% in 2019.”

“The decision to extend QE for a longer horizon also has implications for other central banks like the SNB, Riskbank and CNB that have tailored their policies to those of the ECB to prevent excessive strengthening of their local currencies, the CHF (SNB), SEK (Riksbank) and CZK (CNB). The SNB, RIksbank and CNB all meet over the next two weeks and look certain to reiterate their willingness to intervene in currency markets (SNB) or extend their own bond purchase programme (Riksbank). We do not expect the CNB to drop the EUR/CZL cap of 27.0 until 2H17.”