The European Central Bank yesterday announced strong measures to address economic growth, including a cut in the deposit rate and in the interest rate on main refinancing operations; a €20bn increase in the monthly pace of asset purchases to €80bn; and a new targeted longer term refinancing operations (TLTRO) facility.
“After December’s disappointment, today the ECB announced a strong set of actions that surprised even the most dovish market forecasters,” said David Simner, portfolio manager at Fidelity International.
Corporate bonds the winner
Simner said Europe now has “corporate QE”, with investment grade non-financial corporate bonds now eligible for ECB purchases.
Moreover, the new TLTRO facility “will allow European banks to borrow money from the ECB at a negative rate, potentially as low as -40bp (the new deposit rate after today’s 10bp cut) for 4 years, subject to the amount of loans they provide to the real economy.
“This should encourage further lending to households and corporates, lower borrowing costs and meaningfully reduce banks’ cost of capital.”
"Whilst Mario Draghi won’t say it in public, the ECB will be well aware that it is approaching the effective limits of what it can do to support the economy"
Tanguy Le Saout, head of European fixed income at Pioneer Investments, added that the European corporate bond market will benefit the most from ECB actions.
“We don’t know yet how much the corporate bond buying will be each month, but speculation is that it could be in the region of €5bn per month, or €60bn each year. This demand will act as a strong support for current spread levels and should see corporate bonds out-performing their sovereign counter-parts.”
Euro builds strength
Brigitte Lebris, head of emerging markets debt and currencies at Natixis Asset Management, noted that the proposed measures focused on internal demand by supporting bank credit growth and not on weakening the euro to spur exports.
“It looks as if the objective of depreciating the currency and to rely on external demand is not any more the main objective of the ECB.
“European assets (bonds and equities) are set to rise, and in that scenario euro downside seems now relatively limited.”
Recently some in the industry have sensed diminishing investor confidence in central banks to stimulate economic growth. Indeed, after the ECB announcements yesterday, the US markets were flat, the FTSE 100 and markets in Germany and Paris were down while the euro strengthened versus the dollar.
In the past, the opposite occurred: relaxing monetary policy sent markets rallying and brought the currency down.
Philippe Waechter, chief economist at Natixis, pointed out that the ECB took strong measures in attempt to spark inflation, but its forecast is only 1.6% for 2018.
“It just reflects the one-legged economic policy in the euro area. All the job has to be done by the central bank as there is no proactive fiscal policy. This is a necessity to avoid a break but it is not sure that it will create an impulse in economic activity. The ECB seems to be the sole institution which really wants to move and change the picture.
“I'm pessimistic as the ECB program will reduce liquidity on a large number of assets. It was partly the case in sovereign debt for certain countries. It will now be the case for the investment grade market.”
Likewise, Stefan Isaacs, deputy head of M&G Investments’ retail fixed interest team, said he sees ECB moves losing effectiveness despite yesterday’s measures, which went beyond market expectations.
“Whilst Mario Draghi won’t say it in public, the ECB will be well aware that it is approaching the effective limits of what it can do to support the economy. Areas such as structural reform and fiscal measures will also need to play their role."