Will weak growth data push ECB to cut rates and extend QE?

europe

The European Central Bank is expected to extend its quantitative easing programme tomorrow following the worse-than-expected Eurozone inflation data released today.

According to an estimate from Eurostat, Eurozone inflation rose 0.1 per cent in the year to November, unchanged from the previous month and falling short of the 0.2 per cent year-on-year growth predicted by analysts and the 2 per cent target set by the ECB.

Given the disappointing data, ECB President Mario Draghi is expected to roll out further measures to counter prolonged low inflation, such as extending the quantitative easing programme beyond September 2016, increasing monthly asset purchases and cutting the deposit rate.

“The ECB could cut its deposit rate by at least 10 basis point while extending both the size and duration of its asset purchase programme,” François Raynaud, fund manager at Edmond de Rothschild Asset Management says.

“If the ECB manages not to disappoint investors, equity and bond market should logically applaud Thursday’s decision while the euro will continue to depreciate. However, the ECB wants to act as a watchdog and so could choose not to roll out all its available tools ahead of the Fed’s decision on December 16. The bank knows that it will have to keep any contagion from higher US rates to a minimum. In the meantime, investors will have to deal with high volatility.”

Martin Harvey, fixed income portfolio manager at Columbia Threadneedle Investments, says that the ECB will need to cut the deposit rate by at least 20 basis points to beat expectations.

“Given the high hurdle, we are not minded to position for such outcomes,” he says. “We do maintain an overweight position in peripheral bonds, which should we well supported even in the event of a mild disappointment.

He adds: “While this may be important for investors with specific interest in the bond and interest rate markets, from a big picture perspective it is difficult to see a large move in bond yields from such depressed levels already. It is interesting that the 10-year bund yield is largely unmoved since the previous ECB press conference, as investors are reluctant to fall into the trap of buying duration at low yields and risking a sharp snapback akin to that seen in the second quarter.

“The shift in focus back towards interest rate cuts implies that the ECB is looking towards the currency channel to boost inflation. The recent drop in the Euro suggests that this will be effective, and Draghi will be keen to ensure that the good work is not undone. Rising interest rates in the US should offer a helping hand on this front going into year-end.”