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Focus back on the ECB

18 July 2016 by Gary Kirk

Despite the recent shocking events in Nice and Turkey we expect markets to be relatively benign at the beginning of this week, with most attention being focused on the ECB meeting this coming Thursday. Tomorrow we have the ECB bank lending survey and the German ZEW survey (German economic sentiment) followed by German PPI data on Wednesday, all of which are expected to be fairly subdued.  We have mentioned in the past that the ECB still has a number of additional strategies it can implement to support market sentiment in the Eurozone, particularly in introducing some flexibility to the current asset purchase programme (APP), and it might just be that the ECB decides to add a little stimulus now as we head into the summer period.

The obvious adjustment that they can make would be to relax the restriction on the APP bond purchases which currently have to be at yields above the threshold of the underlying deposit facility rate; meaning the ECB cannot purchase government bonds yielding below the current ECB deposit rate of -40bps. The other slightly more contentious rule they can tinker with, is lifting the capital key as a limiting factor for the asset purchase programme for any given sovereign. Effectively there is ceiling on the amount of bonds the ECB can purchase related to the size of a sovereign’s capital key i.e. the amount of capital that each member state allocates to the ECB balance sheet, which is determined by the size (population and GDP) of the member state in relation to the whole of the EU.

Even though Eurozone government yields have risen since the UK referendum, the ECB has seen vast swathes of its ‘target bond universe’ disappear as rates have turned negative. The ECB has to venture out to 7 year maturities in the German Bund market before they can find a bond at a yield wider than -40bps and they have to go out to 5 years in the French OAT or Dutch sectors.

A combination of adjusting the capital key and deposit rate floor will give the ECB some flexibility and reinvigorate the APP which some analysts claim will run out of bonds and market effect by late 2016. If the ECB does decide to deviate from its current guidelines it should add further support to the market over the near-term and a welcome summer boost. We await the decision this Thursday.

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