GBP/EUR: Expectations of More ECB Stimulus Unlikely, Banca IMI
A lack of supply may put a self-imposed limit on the ECB's QE programme, which could be a factor supporting the euro going into 2016.
It may have been that Ewald Nowtney’s exasperation at the “absurd” expectations of market participants was not so wide of the mark.
According to Fixed Income Strategists at Italy's Banca IMI it is unlikely that the ECB has the scope to increase its asset purchase programme despite market expectations to the contrary.
“The market expectations that the ECB may decide in the first months of next year to step up monthly purchases of government bonds seem unrealistic by all accounts, given the serious constraint already imposed by the size of the German market.”
An increase in Euro-zone government bond Issuance of 150bn in Q1 2016 compared to Q4 2015, is also forecast to weigh on bond prices - but at the same time push up yields.
Banca IMI, FI Strategist Chiara Manenti, expects the spread – or difference between Italian (BTP) and German bunds - to rise to 120 basis points in the new year as a result of the rise in yields, with a suggestion to buy two over five year BTP spreads at 46 basis points, with a profit target of 77 bps.
The expected increase in the attractiveness of euro-zone bonds to international investors seeking higher yields, combined with the falling probability that the ECB will increase its monthly purchases could be supportive for the euro currency.
Disappointment in ECB’s December Meeting unwarranted
According to Manenti, the market may have been overly disappointed at the ECB’s December meeting QE extension to March 2017 (from September 2016 previously).
The extension accounts for a substantial 280bn increase in the bond purchase programme, soaking up the spare capacity available in the European bond market, especially for Germany which has an undersupply problem in relation to the ECB’s programme:
“Despite the disappointment of the market, which had built up exaggeratedly high expectations, the decision taken at the latest ECB meeting, which extends the EAPP until at least March 2017, implies 280 billion euros in additional purchases of government bonds and agencies, marking a 35% increase over the old programme.”
In relation to Germany’s supply problems the note says:
“The stock of Bunds available to be purchased by the ECB will be reduced to a minimum at the end of March 2017.”
It goes on to say:
“If the ECB intends to respect its own rule and not exceed the 33% threshold, a residual 37 billion euros in Bunds will be available for a subsequent tapering phase of the programme, whereas at the present pace of purchases the programme could be only extended by a further four months.”
Supply bump from Muni’s
Despite the shortage of supply of bonds from certain Euro-zone countries, the ECB’s decision to include regional and municipal government bonds to those eligible for inclusion in its asset purchase programme will provide a new source of supply, which will marginally help it to extend its programme if required, however, Banca IMI also note that the it would be unlikely to compensate sufficiently in the case of Germany for a shortage of national debt:
“It is hard to imagine that the ECB will want to significantly overweight the purchases of agencies and local administration bonds: although they represent a market of significant size in Germany (around 200 billion euros outstanding), they are in any case scarcely liquid and largely held as long-term investments in institutional portfolios.”
Restrictions do not only apply to Germany, but also Portugal, as noted by the Wall Street Journal:
“Portugal’s capacity is even tighter. Unicredit estimates the ECB will have already hit its ownership limit by September 2016, leaving the central bank no room to extend purchases for that market.”
Overall the lack of available quantities of bonds, despite the inclusion on municipal bonds may well impose a ceiling on the ECB’s QE programme, which could be a positive factor on the euro as 2016 unfolds.