EZ Rates: ECB policy preview. Expect more entrenched dovishness (Eugene Leow)


EU rates hostage to growth and Covid-19.
Eugene Leow22 Jul 2021
    Photo credit: Unsplash Photo


    Market participants will be looking to see how the European Central Bank (ECB) tweaks policy guidance later today under its newly revamped monetary policy strategy. Some of the key points in the new strategy include:

    -defining price stability to a clear and symmetric 2% target in the medium term (compared to an “inflation rate below but close to 2%” previously)

    -the cost of owner-occupied housing is set to be included in the price index over an unspecified timeframe

    -to react forcefully or persistently to deflationary shocks when close to the zero bound

    -commitment to a comprehensive climate-related action plan

    Forward guidance could be strengthened, but we note that the Deposit Rate has been below zero since 2014 with short-term EUR swaps generally not anticipating any rate hikes for an extended period. We suspect that there would be plans to ensure that quantitative easing remains in place when the Pandemic Emergency Purchase Programme (PEPP, EUR 1.85) expires in March 2022. The current pace of bond buying is about EUR100bn per month (of which EUR 80bn PEPP and EUR 20bn Asset Purchase Programme) and is set to slow to just EUR 20bn when PEPP ends. This would entail a far sharper taper timeline than what market currently expects from the Fed. An asset purchase pace of about EUR30-40bn in April (post PEPP) would probably be more palatable and that would require more leeway for the APP to buy bonds.

    There may not be direct implications on EUR yields / rates. German inflation expectations (as measured by breakevens) have come off high but are still elevated compared over the past few years. We are not convinced that stronger guidance that short-term rates would stay low and that asset purchases would be larger than the current default taper plan (end of PEPP by March 2022) indicate could do much to lift inflation expectations. Longer-term EUR rates are likely still held hostage to the growth outlook and how this could be impacted by rising COVID-19 cases in several parts of Europe. On balance, we think that the Eurozone is better placed than many parts of the world to handle COVID-19 given high levels of vaccinations. However, cautious sentiment is likely to linger, keeping EUR rates depressed until the current COVID-19 wave recedes.

     

    Eugene Leow

    Rates Strategist - G3 & Asia
    [email protected]

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