Head - EMEA Investment Strategy
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Rates and quantitative easing programme unchanged
The European Central Bank (ECB) left interest rates and Quantitative Easing (QE) guidance unchanged in July. The statement remained unchanged from the June statement, including that QE would be continued at €60 billion per month until at least December 2017, and that they might extend the programme beyond 2017 if necessary. The ECB also remains committed to increase the size of QE if required.
ECB President Draghi was upbeat on the Eurozone economic recovery, citing it as robust, broad, and supported by incoming data. The downside growth risks to the Eurozone are predominantly from global factors. Substantial monetary accommodation is still needed in order for core inflation pressures to build and take the rate to nearer the target 2%.
Draghi said future tapering had not been discussed by the Governing Council, despite reports earlier in the week suggesting the ECB were to begin examining scenarios for the future path of QE this summer including initial work on the possible tapering path. There might be more progress on inflation then, and in addition the supply limitations are likely to become more acute. It seems likely that Draghi’s Jackson Hole speech in late August could pave the way for more clarity regarding tapering at the 7th September ECB meeting. The first rate rise is not expected until mid-2019.
The Euro weakened on the announcement before rising to $1.1640 versus the USD. This is 2.4% higher than the end of June, and is well underpinned by the likely trajectory of the economy and monetary policy in the months ahead. Sovereign bonds have been steady today after the announcement, but we remain underweight given the low yields. The Euro Stoxx 50 index is down 0.20%, after initial support taken from Draghi’s comments about firming growth. We remain overweight in European equities, with the growth recovery being reflected in stronger earnings growth and valuations not fully reflecting this yet. In addition the political risks in Europe are lower than they were earlier this year. Inflows into the European equity markets are picking up from low levels and don’t yet reflect the economic upturn.
Overall, the ECB is treading a very fine line, and doing so successfully. Delayed tapering could prompt renewed growth concerns and dampen the equity outlook, while overly aggressive tapering could prompt a sharp bond sell-off. We expect that the September meeting could shift the emphasis more towards the tapering programme, nevertheless is likely to be done in a very gradual and prudent way.