Stars Are Aligned for ECB Tapering to Begin

2017/10/23
European Central Bank

Summary

When the ECB finally begins dialing back its bond-buying program – a move we expect the central bank to announce at its next meeting – it will be because of a confluence of factors, including steady inflation and less pressure on the euro. But the ECB will maintain flexibility to soothe sensitive markets.

Key takeaways

  • Many factors support the ECB’s reduction of QE: economic growth is robust, confidence is high and inflation is above 1%
  • The ECB bought far more net government bond issuance than the Fed ever did, so the impact of tapering won’t be neutral
  • The ECB knows markets will be sensitive to tapering; we expect a dovish tone that provides maximum flexibility

At its next monetary policy meeting, we expect the European Central Bank to announce that it will reduce its securities purchase programme beginning in 2018. Multiple economic and market factors on display in the euro zone support this long-anticipated change of course:


  • The economic and financial environment is conducive to a lower level of central bank intervention in fixed-income markets.
  • The growth rate is uniformly robust, underpinned in equal measure by consumer spending and investment.
  • Leading economic indicators remain bullish, and confidence indicators are at all-time highs.
  • The ECB has fulfilled the most important part of its contract by efficiently combating deflation, with core inflation anchored above 1 per cent.
  • The recovery in the credit cycle also appears sustainable.

Although the markets are fully expecting the purchase programme to be reduced, the impact of tapering will be far from neutral given the hefty sums concerned. For context, compare the influence of quantitative easing implemented by the Federal Reserve and the programme put in place by the ECB. At its current rate, the ECB is buying up more than seven times the total net amount of government bonds issued in the euro zone, whereas the Fed’s programme never exceeded the level of net Treasuries issued.


The ECB is aware that tapering is an extremely sensitive issue for the markets, and it is therefore likely to emphasize that reductions in its bond-buying programme will be more conditional than automatic. This more dovish tone will enable the central bank to maintain maximum flexibility as it exits its non-conventional monetary policy.


The ECB currently benefits from a highly favourable “alignment of the stars”: the economic growth rate among developed countries was recently revised upwards, and the Fed is pressing ahead with the gradual normalization of the federal funds rate. Moreover, we expect to see less pressure driving the euro higher against all other currencies. The recent surge in the euro was tantamount to a tightening of financial conditions, so a turnaround here should provide the ECB with further leeway to begin its long-anticipated tapering process.




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Japan Election: Expect More of the Same

2017/10/23
Japan Election

Summary

A decisive result in Japan’s Lower House elections strengthens Prime Minister Shinzo Abe’s hand and implies the continuation of Abenomics. We expect the government’s accommodative monetary stance to continue and fiscal policy to also become more accommodative due to political expediency.

Key takeaways

  • This decisive result is likely to strengthen Prime Minister Shinzo Abe’s hand and implies the continuation of Abenomics
  • With inflationary pressures weighed down by structurally low wage growth, Japan’s easy monetary policy is set to continue
  • Japan’s government will likely shift to a more accommodative fiscal stance to counteract the rise in populist politics
  • Wider yield differentials globally could curb short-term appreciation in the yen and further support Japanese equities