Market Comment: Draghi takes center stage -- again

News item -

The European Central Bank (ECB) left interest rates unchanged on Thursday and indicated that rates will remain at present levels for an extended period of time. In the press briefing following the meeting, President Mario Draghi stressed that monetary policy would remain accommodative and that there was “very little chance” that interest rates would be increased this year.

The ECB plans to continue its asset purchasing programme at the new monthly pace of EUR 30 billion until September 2018 -- or beyond if necessary. If inflation does not pick up or the outlook becomes less favourable, the ECB says it “stands ready” to increase its asset purchases in terms of size and/or duration.

Market and ECB expectations diverge

It had been expected that Draghi would try to quash the rising expectations of an earlier-than-anticipated end to the central bank’s asset purchasing programme. These expectations had been underway since the release of the minutes of the ECB’s December meeting.
 
Since their publication, ten-year Bund yields had surged, rising to 0.636% this week, at the same time lifting US ten-year Treasury yields to as high as 2.67%. Moreover, in addition to a weaker US dollar, increased market expectations of early deposit-rate hikes had led to an increasingly strong euro, which is a serious risk to the ECB’s inflation target. An inflation target of below, but close to, 2% is the ECB’s one policy goal, and it has been under threat from the appreciation of the euro.
 
While Draghi was speaking on Thursday, the EUR/USD climbed to  above 1.25, reaching levels last seen around three years ago. But the surge stopped, when he said he sees “very few chances of a rate hike” in 2018.

ABN AMRO’s view

ABN AMRO’s view is that the ECB will be slower in withdrawing policy accommodation than expected, given the subdued outlook for core inflation. Although we believe that it is unlikely that the ECB would extend its quantitative easing programme, the tapering period could well continue beyond September 2018. ABN AMRO does not expect any  rate hikes until the second half of 2019.
 
If our view is correct, it means that the repricing of the market’s rate-hike expectations could create challenges for both euro government bond yields and the euro.
 
Fidel Kasikci, Senior Fixed Income Portfolio Manager

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