‘Outdoving’ the market
The ECB’s hawkish tone is not a huge surprise - it would have been difficult for them to “outdove” the market, given the very bearish consensus expectations on European growth and concerns over the effect of trade wars.
Indeed, the ongoing Chinese stimulus and easier global monetary policy driven by the US Federal Reserve may actually stabilise Europe’s external demand and combined with modest domestic fiscal stimulus could even allow the Eurozone to pick up towards the end of the year.
Keeping all options open
Despite the hawkish tone, Draghi said he was keeping all options open, particularly in the event of a worsening outlook. In particular he reiterated several times that the Governing Council does not disregard the possibility of expanding the balance sheet yet again, should conditions warrant.
And while the period of low rates was extended further, some in the market were surprised that the ECB did not indicate that rates could be cut even lower in the coming quarters. Indeed, the ECB’s growth and inflation expectations for this year were revised marginally higher, although later years were nudged down on balance.
Lower for longer
Lastly, the ECB announced further details of the new round of targeted long-term repurchase operations (TLTRO III). These were roughly in-line with expectations. Banks will be able to access long-term funding from the ECB at interest rates between -0.3 per cent and +0.1 per cent (so just 10 basis points more expensive than TLTRO II).
The actual rate will again depend on how much the banks expand net lending into the real economy, thus incentivising the banks to expand credit. These rates will effectively ‘float’, moving up or down with the ECB’s key benchmark rates.
Against very low yields, there is scope for core Eurozone government bonds to underperform other markets from here, particularly vis-à-vis US Treasuries. However, with inflation still very weak and tail risks from global trade tensions, the ECB stands ready to act in European bond markets and has plenty of headroom to do so. The base case therefore remains very much ‘lower for longer’.