The European Central Bank (ECB) have very much taken the ‘kitchen sink’ approach

The European Central Bank (ECB) have very much taken the ‘kitchen sink’ approach, surprising market expectations in a variety of ways, not least an expansion of the asset purchase programme to include corporate bonds and opening the door to paying banks to borrow via the longer term refinancing operations (LTROs). They hope that the measures announced will ease financial conditions and stimulate new credit creation, leading to stronger growth and a return of inflation to target.

While the expansion of the asset purchase programme to include corporate bonds will likely steal the headlines, arguably more important is the pivot by the ECB towards quantitative easing and lending operations as primary tools for stimulating the economy over ever more negative rates. While the ECB lowered deposit rates by 10 basis points (bp) to -0.4% and refi rates by 5bp to 0% at today’s meeting, they believe it is unlikely that rates can be taken much lower than current levels without unwanted risk, although they still believe the move to the current negative level of rates has overall had a positive impact. There has been much speculation over recent weeks over just how low interest rates can go, but recent comments from central bankers globally, not least at today’s press conference, would suggest a reluctance to take interest rates into materially negative territory. That said, the ECB remains explicitly on an easing bias and investors will likely remain wary of the efficacy of these actions unless there are convincing signs that the increase in monetary stimulus has an impact on the economy, especially as previous attempts to boost the economy through unconventional monetary policy have regularly disappointed.

Ahead of the meeting we had closed our positions which looked for lower shorter dated European swap rates, and positioned for a rise in 10 year bund yields. We continue to believe a repricing to higher yields is warranted, as the guidance that rates are unlikely to decrease further, the move to purchasing corporate bonds, and the increase in the issue/issuer limit to 50% is likely to reduce the bund scarcity premium.