The ECB’s quantitative easing programme could be over within the next year and European bond investors are being warned to prepare now as market consensus predicts tapering plans will be confirmed by the central bank at its next meeting.
Today’s ECB decision saw no change to interest rates or its bond buying programme, but there are only two meetings left before the scheduled end of the programme for president Mario Draghi to announce plans to end QE.
The ECB revised its 2017 growth forecasts up to 2.2 per cent for the euro area, compared to 1.9 per cent previously, but the inflation outlook has been lowered to 1.2 per cent in 2018 and 1.5 per cent in 2019 compared to 1.3 per cent and 1.6 per cent respectively before.
In the press conference that followed the release of the Governing Council decision, Draghi said there had been discussions around changes to quantitative easing but that no decision had yet been made.
AB European Income portfolio manager Jorgen Kjaersgaard says tapering could be completed as early as next summer, but that investors should start preparing for uneasy European bond markets now.
Kjaersgaard recommends dialling down duration, particularly through German government bonds, and taking a cautious approach to the European periphery. “Political risk remains high in countries such as Italy and may create volatility particularly in the run up to next year’s general election,” Kjaersgaard says.
However, the fund manager notes investors could take an overweight in European financials and that select opportunities in the GBP space could be diversifiers in a Euro area rate rise environment.
However, Franklin Templeton head of European fixed income David Zahn anticipates bond markets will be “quite relaxed” if the ECB confirms tapering in October.
“We’d expect to see the knee-jerk reaction of a sell-off, particularly in the periphery where the ECB has been a big buyer.
“On the other hand, we don’t foresee a major cathartic sell-off, rather something more modest, coupled with the likely strengthening of the euro slightly.”
However, Zahn says the bond market could abandon its current philosophy of buying on a sell-off, which is encouraged by the knowledge of a known buyer.
“There’s no question that the ECB is worried about the euro’s appreciation but there’s little [Draghi] can actually do about it,” says Aberdeen Standard Investments senior investment manager Patrick O’Donnell.
The currency broke above $1.20 during Draghi’s press conference, which followed the policy decision. At the end of last year it had been at $1.05.
Markets know there is only so much the ECB can do to slow the single currency’s appreciation, O’Donnell adds.
“Currencies are a relative game and the euro needs help from the dollar or sterling. Unfortunately for Draghi, with the dollar and sterling remaining relatively unloved, the euro will keep going up.”
Columbia Threadneedle Investments head of global rates and currency Adrian Hilton says if the currency hits $1.25 the bank may find itself trapped between a disinflationary exchange rate and a need to phase out its QE purchases before it runs out of bonds to buy.