Bond investors will have been closely observing the European Central Bank’s (ECB) monetary policy stance over the past few years.
The central bank has been lagging its UK and US counterparts in terms of monetary policy for many years but looks to be on a similar path now, following improving economic data from the region.
ECB president Mario Draghi announced at its October meeting that following years of monetary stimulus, during which billions of euros were pumped in by the central bank, it was beginning to taper – albeit slowly.
From January 2018, the ECB’s bond-buying programme will be scaled back from €60bn a month to €30bn a month.
This marks the beginning of the end of unconventional monetary policy in Europe, although Mr Draghi has been clear of the need to reinvest the proceeds of its bond purchases for as long as necessary.
Unlike the UK and US, however, Mr Draghi has not begun raising interest rates and could still be some years away from doing so.
Slow and steady
What has prompted this very cautious change in direction from the ECB?
Rogier Quirijns, senior vice president and portfolio manager at Cohen & Steers notes: “After years of sluggish growth, Europe’s prospects have brightened considerably amid rising consumer and business confidence, a healthy job market, continued low inflation and a marked improvement in the region’s political climate.”
Chris Iggo, chief investment officer, fixed income at Axa Investment Managers, says: “Looking at the ECB it is still a net buyer, having taken modest steps towards exiting quantitative easing (QE) by announcing that it would reduce its monthly asset purchases to €30bn per month from January and would look to terminate the buying programme in September 2018.
“This was in line with market expectations, on the whole, and was sugar-coated by relatively dovish comments from President Draghi.”
He believes the ECB’s motivation for continuing to be accommodating is easy to understand.
“Inflation is running at just 1.5 per cent in the euro area, the recovery is still in its infancy relative to other parts of the world, and there are political risks to the stability of parts of the sovereign debt markets,” he reasons.
“Rate hikes in Europe are also distant which will allow the yield curve to remain relatively steep (117 basis points between German 10-year and two-year bonds) and this is good for banks and the broader economy.”
Mr Iggo points out: “The importance of the ECB’s ongoing buying is no better illustrated than by the fact the spread between Spanish government bonds and German bonds has been pretty stable despite the ongoing situation in Catalonia.
“If the ECB wasn’t buying or had announced a more rapid winding down of its QE programme, I suspect that Spanish spreads would be much higher today than they are.”