Euro Zone banking on Draghi to spur economy

While Mario Draghi has regularly surprised financial markets, the European Central Bank president will struggle to pull off another coup this week, so high are investors’ expectations for new policy measures to stimulate the Euro Zone economy.

Markets are variously pricing in an interest rate cut, plus an increase in the size, scope and length of the ECB’s quantitative easing (QE) programme of bond buying when its Governing Council meets on Thursday.

Euro Zone government bond yields crept higher on Monday, with markets viewing bold easing measures as pretty much a done deal.

The euro hit a 7-1/2 month low at $1.0563, having lost 7 per cent since the last ECB meeting on October 22 due to expectations the US Federal Reserve will move in the opposite direction — raising rates for the first time in nearly a decade.

European shares rose on the prospect of more stimulus as the ECB tries to nudge up inflation closer to its target.

Money markets are expecting a cut of at least 10 basis points in the ECB’s deposit rate, while economists in a Reuters poll predicted the bond-buying will be increased to €75 billion a month from €60 billion.

Beyond that, there is talk of extending QE beyond the current end date of September 2016, including expanding from buying sovereign bonds to municipal debt and even of non-performing or “bad” loans.

A two-tier deposit rate system, which Reuters revealed last week was one of the options policymakers are considering, may allow the ECB to cut even more aggressively.

After pushing short-term debt yields to record lows in the past week — with even the five-year German bond yield falling below the ECB’s -0.20 per cent deposit rate — investors are wondering whether expectations have gone too far.

Since becoming ECB chief in 2011, Draghi has sprung a series of surprises, first to tackle the Euro Zone debt crisis and then to head off the risk of deflation and revive economic activity.

He launched long-term refinancing loans to encourage banks to lend more into the economy, set up the bond-buying safety net after promising in a 2012 speech to do “whatever it takes to preserve the euro,” and announced the current QE programme would be worth one trillion euros.

But can he do it again? “I'm not sure the ECB will be able to surprise us any more,” said Natixis fixed income strategist Cyril Regnat. He expects a €20 billion increase in monthly debt purchases, a six-month extension of QE and a 10-basis-point deposit rate cut. Euro zone yields were 1-3 basis points higher on Monday.

German 10-year Bund yields were up two basis points at 0.47 per cent, off a one-month low of 0.44 per cent hit on Friday. Two-year yields were flat at minus 0.40 per cent, while five-year yields were slightly higher at minus 0.185 per cent.

“There is a sense that Draghi and colleagues are evaluating all options and this should make for a very interesting meeting on Thursday,” said Mark Dowding, partner and co-head of investment grade debt at BlueBay Asset Management.

Regnat at Natixis said the ECB should keep some firepower for later when it would be able to assess the impact of an expected interest rate increase by the US Federal Reserve.

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