To moderate downside risks to the European financial sector, we think what the ECB decides to do with interest rates next week is less important than what it could do in terms of its own and the private sector repo market. We believe that two policies it could deliver would particularly support the functioning of money markets. Firstly, the ECB could deliver areduction in the graduated haircuts it attaches to repo collateral, in a manner that wouldlower the credit differential between eurozone sovereign bonds, and which could spur afurther rally in the belly and long-end of regional curves. For the far more important privatesector repo market, the ECB should act to reduce the current shortage of high-quality repocollateral – a shortage aggravated by sequencing problems as regulatory reform of thefinancial sector is advanced – by releasing more AAA securities, possibly by creating a Fed-style TSLF programme in combination with a BoE SLS programme issuing ECB bills to highloan-to-deposit ratio institutions. However, we are not confident these changes will beimplemented next week. This is problematic since the current dynamics of the private sectorrepo market suggest that any possible downgrade of France could have a far greater impactthan commonly assumed, which argues strongly in favour of the ECB moving to stabilise thefunding markets in a more proactive manner.
This week, the ECB will hold its monetary policy meeting on Thursday (July 20th), three weeks after Draghi’s upbeat speech in Sintra which spooked the significant rise of bond yields and the euro. In our view, based on the current economic condition, it is almost inevitable that the ECB will start tapering in 2018, given the steady economic recovery of the Eurozone. Thus, as we have addressed, no major policy shifts are expected in 2017; but the focus of this week’s meeting should be setting the stage for tapering, i.e., clarify the ECB’s action plan of QE tapering to get the market prepared; and at the same time also prevent any involuntary tightening of financial conditions.
In sum, we expect the ECB to clarify its action plans in the July meeting, but not necessarily switching to a dovish tone. As the market has more or less priced in such a tapering after the recent speeches from the ECB, we do not expect dramatic market moves only upon hawkish tones anymore.
野村国际(香港)有限公司 Guy Mandy
Thus, with the tapering in prospect, corrections in asset prices are inevitable. But, it will be better to have the corrections in a series of smaller steps that can be digested by markets rather than in one large bound. So, in our view, turning back to dovish stance in the July meeting will be unwise.
Besides, the ‘scarcity’ of eligible German debt has become a notable technical issue. The German sovereign bonds purchases have been falling in recent months, as the 33% limit is about to be reached; and due to the capital key restriction, it is hard to substitute the German bonds with other sovereign bonds. So, without any adjustments to the purchasing rules, such technical limits suggest the need for QE tapering in the near future.
Secondly, to prevent any involuntary tightening of financial conditions, the ECB will need to clarify its action plans that the current QE program will last until the end of this year and any actual policy shifts would only happen next year. We expect the ECB to send signals that the official announcement of QE tapering (with specific details and timeline) will be in September, and the tapering will start at the beginning of 2018. Such action plans are basically consistent with the ECB’s guidance from previous meetings and are more or less in line with market expectations. Thus, in our view, it is less likely to trigger dramatic market moves further.
Are there any possibilities that the ECB will surprise the market? We see two scenarios, but both with low odds: 1) start QE tapering in end 2017; and 2) taper the QE program at a faster pace compared to market expectations (for example from EUR 60 billion per month to 0). Either of the two scenarios could spook the surge of Eurozone bond yields and euro. But in our view, the odds for both cases are very low. The recent upbeat of economic performance, especially the manufacturing factor, still relies on the weak euro; and the weak inflation momentum should keep the ECB cautious. The euro has already appreciated against the dollar by almost 10% this year; further appreciation could weigh on the economic recovery and inflation.
To be specific, firstly, there is no need for the ECB to row back the hawkish stance, as the tapering is already in prospect. The Eurozone’s recovery has consistently been resilient. After a solid growth of 0.6% QoQ in 1Q, the PMI readings kept suggesting a 0.6-0.7% QoQ growth in 2Q. Moreover, the upbeat in PMI data was finally confirmed by hard data: the May industrial production grew by 1.3% MoM, the best performance since last November, suggesting the realized gains in production. So far, we see no signs showing that the impressive economic performance could end soon.