27.10 Weekly Viewpoint : Far from causing market “incidents”, the ECB’s announcement of the extension of the APP programme, at half the previous volumes, was received positively.

The measures confirms that official interest rates will remain negative at least until 2019. The APP is unlikely to continue beyond September 2018. Furthermore, the bulk of the reduction in purchases should be concentrated on government bonds, with a drastic reduction in the relative contribution of the PSPP to overall purchases…….

Yesterday, the ECB took another step towards the removal of non-conventional measures put in place during the crisis, and managed to do so without triggering a negative reaction on the markets. The APP programme has been extended until September 2018, without ruling out the possibility of a further extension if needed, and cutting the monthly reinvestment target from 60 to 30 billion euros per month, starting in January 2018. This part of the announcement is compatible with pre-meeting analyst consensus. Furthermore, the ECB once again reasserted that rates should remain stable well beyond the end date of the programme, and that main and 3-month refinancing operations will continue to be conducted with the full allotment mechanism (i.e. no rationing of requests) at least until December 2019. Lastly, the ECB will continue to reinvest portfolio assets upon maturity, and will soon start to provide information on maturities in the 12 following months.

The combination of these measures guarantees the anchoring of the short end of the curve, and has generally strengthened current market expectations for stable rates until 2019. The exchange rate also moved, as if prompted by an expansionary surprise: the euro/dollar exchange rate, which fluctuated between 1.173 and 1.188, dropped as far as 1.162. The decline of the euro was widespread, and also extended to the bilateral exchange rate against sterling, the Swiss franc, and the yen.

For what concerns the purchase programme, the weight of the tapering process will probably be felt more by the PSPP than by the other programmes, in relative terms, as was already the case in 2017. In essence, the Eurosystem’s efforts are mostly concentrated on the CBPP3, CSPP and ABSPP, and the PSPP is therefore used residually to reach the monthly objective. As a result, the relative contribution of the PSPP to the monthly objective will probably be smaller than it is today. As a result, on some markets net issues will resume marginally exceeding ECB purchases, even considering the additional flow tied to reinvestments. However, this will not apply to the German market, where the shortage effect will continue to weigh, albeit significantly less than in 2017, nor to the Eurozone as a whole – for which we expect purchases to exceed net issues by over 40 billion euros in 2018. For this reason as well, it is hard to say whether the programme may be further extended beyond September: an extension of purchases, if approved, would probably be very limited in time and in size, and would mostly be addressed to further smoothing the exit process, than to injecting new stimulus. Therefore, the programme remains formally open-ended, whereas in practice its termination should not be delayed much beyond September. Also, the reduction in purchases is still likely to be accompanied by a new upward adjustment of medium and long-term rates.  Despite the prospect of net issues in Italy and other peripheral countries being covered only in part, and despite the Catalan crisis, the announcement had positive repercussions on sovereign differentials as well. Expectations for rates to stay low at length are helping, and in the years ahead will aid the process of reducing government debt ratios.


Appendix
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Source: BONDWorld