ECB to recalibrate dovish expectations


ECB to lower deposit rates by 10bp to -0.50%, introduce a tiered deposit scheme, enhance LTROIII and signal upcoming asset purchases.
Radhika Rao, Philip Wee11 Sep 2019
    Photo credit: AFP Photo


    Eurozone: ECB to cement dovish path

    The European Central Bank Governing Council is likely to cement a dovish path until at least the end of 2020, when they meet on Thursday. Markets have bet heavily on aggressive policy support, reflected in the sharp decline in core and peripheral 10Y bond yields, 2Y yields slipping below the deposit facility rate (of -0.4%) and drop in EONIA rates. As the DBS Strategist noted last week, entire yield curve of highest-rated Germany and Netherlands is below zero, with lower-rated papers like Portugal also negative up to the 7Y tenor.

    We expect a mix of easing measures – dovish forward guidance, 10bp cut in the deposit facility rate (currently at -0.4%), introduction of a tiered deposit scheme to temper the impact of this cut, (which will turn) LTROIII on attractive terms and signal upcoming asset purchases. The decision to resume QE will not be easy as the Council remains split, with hawks – Germany, Netherlands, Austria and Estonia central banks and an executive board member - cautioning against turning hostage to market expectations.

    Markets have run ahead of themselves. Any sign that the ECB has fallen short of expectations might result in short-term unwinding in positions. Wary of the overwhelming burden on monetary policy, the incoming ECB chief Christine Lagarde has already called for fiscal policy to play a more proactive role, to support growth and reverse a decline in inflationary expectations. Besides a prolonged US-China trade dispute, EU leaders are also likely to monitor Brexit developments closely as the political tug of war escalates ahead of the October 31 deadline.

    FX: EUR to recalibrate with ECB expectations

    The euro has been hesitant to trade below 1.10 in September. Heightened expectations for ECB President Mario Draghi to announce a “big bazooka” stimulus during his final governing council meeting on September 12 have waned. The euro is also getting a brief respite from two external factors that have weighed heavily on the Eurozone economy. First, hard Brexit fears have dialled down with the shutdown of the UK parliament till October 14. Second, trade war rhetoric has cooled ahead of the China-US trade talks scheduled for early October. The euro’s correction (recovery) has been symptomatic of the fatigue that has set in for trade tensions, Brexit and the flight to safety into sovereign bonds.

    It is premature to call the bottom in the euro. Until British Prime Minister Boris Johnson has resigned or requested Brussels for another Brexit delay, the possibility of the UK exiting the EU without a deal on October 31 cannot be fully dismissed. Hopes for a de-escalation in trade tensions run counter to US’s intentions to take China to task on currency manipulation (at the trade talks) and the scheduled additional 5% US tariffs on USD550bn of Chinese goods on October 1. These are the two risks that will keep Mr Draghi dovish over the threat posed by the weak Eurozone outlook to the ECB’s price stability mandate. Resuming the asset purchase program will probably be left to Mr Draghi’s successor, former IMF Chief Christine Lagarde.

     

    Radhika Rao

    Economist – India, Thailand & Eurozone
    radhikarao@dbs.com


     

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com



    The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

    DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.

    PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No. 09.03.1.64.96422.