Chris Ciovacco: The European Central Bank has telegraphed most of what will be contained in Thursday’s statement. The wild card, in terms of market reaction, most likely lies in if/how the ECB addresses the subject of quantitative easing. From an investment perspective, the markets have most likely priced in the core portions of the Thursday’s ECB statement; QE is the exception. Since QE can impact stocks, bonds, commodities, and currencies, the market may be disappointed if the ECB fails to hint at the possibility of implementing a QE program.
What’s The Problem In Europe?
There are numerous problems, including persistent low inflation and a wide spread between lending rates for borrowers in different countries. Borrowers are paying higher interest rates on loans in Italy and Spain relative to Germany and France. The economies in Spain and Italy are much more in need of the economic benefits of low borrowing rates, which can spur building, investment, and hiring. We have touched on theproblems associated with low inflation in the past; an issue on the ECB’s short-term radar.
The Telegraphed Expectation
The head of economic research at Open Europe, Raoul Raparel, handicapped the widely expected key moves to be announced by the ECB. From Forbes:
- Cut the main interest rate to 0.15% (from 0.25% now).
- Cut the deposit rate to -0.1% (from 0% now). This will be an unprecedented move.
- Announce a new Long Term Repurchase Operation (LTRO) focused on boosting lending to small and medium sized businesses. The term will be between 3 and 5 years, rates will be reduced if banks provide evidence of a pick-up in lending (see below for a useful Nomura graphic on this, the 1st and 2nd options are most likely).
Buy The Rumor, Sell The News
If there is little-to-no mention or hinting of the possibility of future QE in the ECB’s statement, the odds of a negative “sell the news” reaction increase. From Bloomberg:
Yields on bonds from Belgium, France, Italy and Spain have fallen to records in the past month amid speculation policy makers meeting tomorrow may add unconventional measures, such as quantitative easing, in addition to lowering interest rates… “We see a high risk there will be disappointment,” Cosimo Marasciulo, Dublin-based head of government bonds and currencies at Pioneer Investment Management Ltd., which oversees about $244 billion, said yesterday. “The market is looking for some form of QE, or at least an opening of the door to QE, and we think the ECB will be reluctant to do this. Those who bought bunds and Italian bonds on expectations that QE in the euro zone was very close may be disappointed.”
Investment Implications – Don’t Expect A QE Announcement
The odds of the ECB announcing plans to begin a QE campaign are not zero, but they are very low.