QE is dead, long live enhanced forward guidance and reinvestments

14/12/2018

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Andrew Mulliner, portfolio manager within the Global Bonds team, reveals an inconsistency within the European Central Bank’s decision to end quantitative easing.

 
The fact that the euro traded in a 0.5% range all day on Thursday 13 December, and German government 10-year bond yields ended the day within a basis point of where they opened, tells the story well enough*. Thursday’s European Central Bank (ECB) monetary policy meeting saw the curtain brought down on ECB quantitative easing (QE) – or rather an end to net asset purchases at the of the month. This had been widely telegraphed over the course of the last year and clearly had been priced in by markets ahead of Thursday’s ECB announcement and press conference. 
 
However, if the banner items of Thursday’s press conference conformed almost entirely to expectations, it was the incongruence of the ECB’s communications around the increasing downside risks to the outlook that caught the eye. While Draghi was at pains to emphasise the strength of the domestic economy, it was notable that in the ECB’s view, “the balance of risks is moving to the downside” as have the ECB’s staff forecasts for growth and core inflation for the coming years. The writing has been on the wall for the ECB’s QE programme for over a year now as various members of the governing council have become increasingly critical of the super-accommodative stance. However, the steady weakening of economic and sentiment data, coupled with another year of downside misses to core inflation, make the decision to end QE now look rather awkward. While today’s economic situation is nowhere near as dire as we have experienced in the past ten years, once again investors might reasonably ask just how much capacity the ECB has to act should these downside risks increase. The inconsistency of the actions of the December meeting, combined with the less optimistic forecasts and increased downside risks, leaves one wondering whether political expediency, rather than economic circumstances, is the driver of today’s decision.
 
*Source: Bloomberg, 13 December 2018, EUR-USD spot rate, German 10-year government bond yield.

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