As largely expected, the European Central Bank confirmed a plan for tapering its asset purchasing programme, reducing monthly purchases down from €60 billion to €30billion, from January and up until the end of September but beyond also if necessary. The majority of the reduction should be in government bond purchases with the corporate credit purchases relatively unchanged.
Market reaction has been fairly muted so far. We think this is because the central bank has been communicating the likelihood and the timing of these events well over the last few months.
That said, we think the key thing to bear in mind is that while this should set the ECB on the path to monetary policy normalisation, we don’t expect this to be a quick journey. The ECB is committed to remaining accommodative for some time, and its tapering of bond purchases will be slow and steady. In addition, interest rates in Europe will continue to remain low, until the central bank seems some progression towards its 2% inflation target – and we do not expect that to happen before 2020.
We think the ECB’s cautious approach is the right one. It has already spent more than €2 trillion on asset purchases since embarking on its QE programme in March 2015. In our view, it will want to make sure it doesn’t do anything to upset the market in a way that could make that commitment redundant.
Furthermore, even as the ECB winds down its asset purchases, we would expect to see the bank reinvesting in maturing securities. That reinvestment is likely to serve almost as a substitute for QE and could maintain the downward pressure on yields for longer.
However, while we think there will likely be sustained upward pressure on yields overall, given the majority of the tapering is going to happen in the government bond market, we expect to see some volatility in government bond yields, specifically in the periphery over the next few months. On top of that, political risks in Europe continue, with tensions in Spain, and the ongoing Brexit talks the main issues at present. The story in Europe is never quiet and over the next 12-18 months, we think ongoing volatility will continue to present opportunities for managers to capture opportunistic pockets of yield.
David Zahn - head of European fixed income - Franklin Templeton Fixed Income Group
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