#Market Strategy — 03.12.2015

ECB decisions below (high) expectations

Florent Bronès

Over the past few weeks, the ECB has been preparing financial markets regarding the possible next steps.

The facts before the ECB meeting

Over the past few weeks, the ECB has been preparing financial markets regarding the possible next steps. It was looking to work on 3 type of tools: (1) a more negative deposit rate (weaker Euro and more pressure on banks to lend), (2) a lengthening of the asset purchase program and (3) an increase in the monthly purchases of assets (more money in circulation to push inflation expectations higher).

Most market participants were expecting a decision on all policy tools mentioned above.

The policy announcement today

The ECB has decreased its deposit rate by 10bp, which stands now at -0.30%. The refi rate was unchanged at 5bp, while the marginal lending rate was kept at 30bp.

The rate cut was below expectations and this suggests that the ECB is likely to prefer a step-by-step approach regarding the deposit rate.

During the Q&A that followed the rate decision, Mr. Draghi announced that the ECB will continue the asset purchase program until “at least March 2017” and would use a wider range of assets. The monthly amount was however left unchanged at 60 billion euros.The latter was a disappointment for markets.

Further measures are likely depending on the evolution of long term inflation expectations. These are measured via financial assets such as “breakeven“ inflation rates which are implicit in inflation indexed bonds.

The market reactions

The Euro was in the focus as an indicator of market sentiment. The common currency has been rising quite sharply against the dollar especially over the course of the Q&A. The value of one Euro almost touched 1.09 but stabilized around 1.08 (1.055 before the announcement). As mentioned, the market disappointment came probably from the fact that the monthly purchases were not raised and thus limiting the total QE amount versus market expectations. Other assets also reacted with most European equity markets reversing the earlier gains into losses around -3% in the midafternoon. Yields on German Bund were up around 10bp to 0.58%.

We expect the market reaction to be temporary once markets realize that expectations were probably exaggerated and that the ECB remains committed to do what is necessary to stabilize inflation and inflation expectations. Inflation should be moving gradually higher supported by a stabilization in oil prices. Recent economic indicators suggest that the Eurozone economy is recovering on a broader scale. This should also help improving wage growth and thus inflation.