Global daily insight 21 october 2016

Daily Insight

Group Economics Macro & Financial Markets Research

21 October 2016

ECB signals December decision moment Macro & Financial Markets Research team Tel: +31 20 343 5616 nick.kounis@nl.abnamro.com

ECB press conference: Draghi non-committal, but tone dovish - The ECB left its policy rates and asset purchases unchanged. It also communicated exactly the same forward guidance as in September. In the press conference, ECB President Draghi’s main message was that December would be a decision moment for the Governing Council. This reflected that the ECB would have input from the Committees that are looking at options to expand the eligible universe of assets at that time. In addition, the ECB will have the updated macroeconomic staff projections, including those for 2019 for the first time. Mr Draghi remained non-committal for the rest, saying the ECB neither discussed tapering nor extending QE, though he did also note that ‘an abrupt end to QE is unlikely’. Still, his general commentary was dovish. He said that there were ‘no signs of a convincing upward trend in core inflation’. This is a strong signal as the ECB’s forward guidance is that asset purchases will continue until ‘the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim’. In addition, he continued to see the risks to the economic outlook as being tilted to the downside. Finally, he stressed ‘the need to preserve the very substantial amount of monetary support that is necessary in order to secure a return of inflation rates towards levels that are below, but close to, 2% without undue delay’.

(Nick Kounis) ECB outlook: Extension of QE and removal of depo rate floor in December - Overall, it is clear that Mr Draghi did not want to pre-empt the outcome of the next meeting, but his dovish commentary suggests the ECB is likely to extend QE in December in our view. We continue to think that the ECB will expand the duration of its QE programme from March 2017 currently to September 2017 in December. To expand the universe of assets, the ECB will likely decide to start buying bonds that yield less than the deposit rate (so far restricted) as well as buying bonds below the 2y maturity. Finally, we also expect that the ECB will relax the criteria to conduct substitute purchases. We think that these policy actions will put downward pressure on Bund yields, especially at the short end. This means we would see a ‘bull’ steepening of the yield curve. (Nick Kounis) Euro government bonds: What will happen if Portugal’s rating is downgraded by DBRS? - The Canadian rating agency DBRS will announce its rating review of Portugal after close of business today. The decision is important as DBRS is the only of the four rating agencies recognized by the ECB that still rates Portugal’s bonds as being investment grade (and with a stable outlook). If DBRS were to lower its rating, Portuguese bonds would no longer be eligible for the ECB’s QE programme and also could no longer be used as collateral by banks in the ECB’s refi operations. In such a case, it would need to receive a special waver from the ECB for the bonds to be reinstated as collateral again for the liquidity operations. A waiver would only be granted if the Portuguese government would enter a new EU-IMF reform programme and be compliant with it. There are significant risks in such a scenario as Portugal’s minority government would probably have a hard time committing to a stringent reform programme. The conditions to become eligible again for the ECB’s QE

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Bloomberg: ABNM

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Daily Insight - ECB signals December decision moment - 21 October 2016

programme are even stricter. Besides the commitment regarding the reform programme, the ECB will also take into account certain ‘risk management considerations’. Although it is unclear what these ‘risk management considerations’ consist of, we judge that in such a scenario it will take considerable time for Portuguese bonds to become eligible again for QE purchases. This has up to now also been the case for Greek bonds, which can be used for collateral purposes but are not bought under the QE programme. Yields on 10y Portuguese bonds have declined and have performed from around 360bps to 310bps over German bonds lately, which shows that the market has taken a positive stance. Our spread forecast for the end of the year stands at 350bps over German bonds, which is still well within reach.

We expect peripheral spreads to widen again as political risks related to the Italian constitutional referendum will flare up at the end of Q4. (Kim Liu & Aline Schuiling)

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Daily Insight - ECB signals December decision moment - 21 October 2016