ECB meeting takes centre stage

As had been widely expected, the ECB’s MPC members opted to keep interest rates unchanged. But the key take from yesterday’s meeting was that the ECB is being interpreted as having taken a small but meaningful step towards acknowledging that additional reductions in the CSPP could be well on the cards. ECB’s Mario Draghi’s message was clear in opining that the eurozone’s economic outlook as markedly improved and that, more importantly, the ongoing debates within the Governing Council on the trajectory of monetary policy was gathering steam.

Draghi stated and acknowledged that the Eurozone economy is slowly getting back up on its feet, the economic recovery is seemingly gathering momentum and that the recent bout of economic data has made the ECB more confident that the robustness of data will translate into a more sustainable economic recovery, and will continue to ‘firm and broaden’. As Draghi put it, the balance of risks was still described as “tilted to the downside,” but these risks are now seen as “less pronounced” as before.

Draghi’s tone was also optimistic in nature when speaking about the ECB’s upward revisions to both its growth and inflation projections; the ECB is now seeing GDP growth at 1.8% for 2017 and 1.7% in 2018, 0.10% for both projections as indicated by the ECB itself in its December MPC meeting. On the inflation front, the ECB has revised its expectations for 2017 by 40 basis points to 1.70% and by 10 basis points in 2018 and 2019 to 1.5% and 1.8%, respectively. More importantly in our opinion, we are aware that whilst short-term revisions to inflation mainly reflected changes to what’s happening in the energy sector, core inflation was also revised up slightly.

All in all, there was no meaningful change in the monetary policy outlook of the ECB as Draghi reiterated once more that “a very substantial degree of monetary accommodation is still needed” to push inflation sustainably towards its target, whilst also stating that the commitment to buy assets at a pace of EUR 60bn a month until at least December 2017.

What to us is of great importance at this juncture is that fact that, in his statement, Draghi this time refrained to indicated that the ECB would exploit all possibilities of “using all the instruments available” if warranted, adding also that the chances of lower real rates from this point forth and additional bouts of lower rates and more QE had diminished, given the improving economic outlook. This gives us reason to believe that possibly as early as September, we could see yet another reduction in the current asset purchase programme and, also an increase in its current deposit rate.

Within this context, European sovereign bonds lost further ground, as expectations of an improving economy sent yields markedly higher. Next up is the calendar-heavy political scenario in Europe unfolding over the next 3-4 months. If credit markets manage to withstand this period, they could well register positive gains, even within the context of rising yields and a reduction in the ECB’s asset purchase program. For the rise in yields to significantly dent credit markets, they would have to rise markedly from current levels. With the eventual CSPP fading away, we expect credit to adjust accordingly, a process which would be stretched on a long period of time and not in an abrupt manner.