The Investment Implications Of The ECB’s Tapering Plan

From Invesco: The European Central Bank (ECB) communicated its plan this week to wind down its asset purchase program (quantitative easing, or QE) by the end of this year.

The ECB announced it would begin a three-month period of “tapering” in October, reducing its bond purchases to 15 billion euros per month from a current level of 30 billion. The ECB said it will continue to reinvest the principal from its holdings for an extended period of time in order to maintain favorable liquidity conditions and ample monetary accommodation. We at Invesco Fixed Income believe this plan should continue to support asset prices and ensure a smooth normalization process.

Interest rates to remain steady

While the ECB’s plan is in line with our expectations, it surprised some market participants given the recent wave of disappointing European macroeconomic data. Today’s relatively hawkish taper announcement was, however, coupled with dovish forward guidance suggesting that the ECB will keep interest rate increases on hold until at least the summer of 2019.  The introduction of this calendar-based guidance dominated market sentiment and weighed negatively on the euro.

ECB downgrades its 2018 economic forecast

ECB President Mario Draghi expressed confidence in the future path of European growth and noted that progress on inflation has been substantial, while acknowledging downside risks from external trade and a pull-back in global growth. He also noted that the risk of market volatility warrants monitoring and that the recent growth soft patch may last longer than expected. The ECB downgraded its 2018 gross domestic product (GDP) growth forecast to 2.1% from 2.4%, on the back of weaker-than-expected first quarter eurozone GDP growth, which was dragged down by weak export performance. The ECB left its 2019 and 2020 GDP forecasts unchanged at 1.9% and 1.7%, respectively.

Invesco Fixed Income expects above-trend growth

We believe the recent moderation in growth has been due mostly to temporary factors such as trade war concerns, political uncertainty (including the formation of an anti-establishment government in Italy, which raised concerns over eurozone stability), disruption caused by transport strikes in France and poor weather conditions, which have weighed on both consumer sentiment and business activity.  Economic data for the second quarter is showing a mixed picture so far with business surveys stabilizing and consumer confidence still robust, but industrial production and certain leading indicators have softened, although from arguably unsustainable levels. That being said, the latest survey data remain at historically high levels and the growth outlook remains promising, in our view. We expect the eurozone to continue to grow at an above-trend rate of around 2.1% in 2018.

Higher core inflation looks likely

The ECB raised its inflation forecasts from 1.4% to 1.7% for 2018, as higher oil prices have finally begun to feed through to euro-area inflation, with headline consumer price inflation climbing to 1.9% in May from 1.2% in April.1 We expect energy inflation to remain elevated over the summer, which should continue to boost headline inflation. Core inflation has remained muted, however, measuring 0.7% in April and 1.1% in May. While we do not expect a significant jump in inflation in the months ahead, we think a shift toward higher core inflation is likely by the end of the year to around 1.2%, as wage gains across the eurozone begin to generate upward price pressure.

1 Source: Eurostat, April data as of May 3, 2018, and May data as of May 31, 2018

Important information

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Quantitative easing (QE) is a monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective.

Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.

The Vanguard FTSE Europe ETF (VGK) closed at $58.59 on Friday, down $-0.44 (-0.75%). Year-to-date, VGK has declined -0.46%, versus a 4.26% rise in the benchmark S&P 500 index during the same period.

VGK currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #34 of 91 ETFs in the European Equities ETFs category.

This article is brought to you courtesy of Invesco.