Date: 2 July, 2018 - Blog
A media reported that the ECB is concerned about the loss of duration in its portfolio. It would be inclined to reinvest redemptions in 2019 and beyond into long-dated bonds, generally seen as bonds maturing in 10 years or more. The idea is to flatten the yield curve and keep term premiums low, or in other words, to avoid chaos in the European bond market, like the Fed did in 2011. Twist operation would certainly keep long-rates indefinitely low. The problem is that such a move would further cripple European banks who are struggling to make profits at a time when negative interest rates and QE have collapsed the European yield curve. However, there is emphasis that the main policy tool in 2019 will be forward guidance on interest rates.
This report came just after the latest ECB Governing counsel message, which confirmed that interest rates will be on hold for a very long time. The ECB expected that its key rates will remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with its expectations.
This led to a sharp scaling back of market rate hike expectations. So, recent ECB commentary suggests that this trend may have further to go. ECB member Vasiliauskas – usually a moderate – mentioned that in Europe summer period means end of September. He suggested that a rate hike may not happen until the very end of 2019. This remark follows dovish ECB President Draghi and Chief Economist Praet comments. Markets are still expecting an earlier rate hike than our current baseline scenario. This leaves current market pricing too optimistic given the recent ECB comments.
- We are expecting a flatter curve in the coming months
- Italian spread over Germany will remain volatile
