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13 September 2019


So Mario Draghi went out with a bang. The ECB has delivered all the expected goodies, even if more had been expected by some regarding QE and regarding the size of the rate cut.

But the tiering system and especially the open-ended policy imply rates are going to be lower for longer. There needs to be a solid rise in inflation before QE stops and before rates rise. That is clearly independent from any time schedule. The action announced on TLTRO III is also more positive as it will be cheaper and longer (3 years instead of 2). Thinking about it, the news is more supportive for peripheral bonds and markets because lower rates for longer helps indebted nations more than frugal nations. And obviously peripheral banks are the biggest beneficiaries of TLTROs.

The ECB President made it quite clear that he aimed to help the banks stating that financing in Europe is a banking matter. And indeed, the tiering system alleviates the pain of negative rates. It also opens up the door to more rate cuts, if needed. But Mario Draghi hinted that most of the work was now done. The governments are up next, using fiscal policy. Helicopter money is not going to happen, distributing cash to the eurozone’s inhabitants is a task of the governments, not the Central Bank. Meanwhile, the new European Commission has been said to be more open to changes in the orthodox budgetary rules of the EU. And Germany said it would be ready
to use billions to kick-start the economy again, if needed.

The net result is that interest rates and bond yields will stay low. But that does not imply they will fall from current levels. The summer months have seen bond yields overshoot to the downside. The 10y Bund yield can stay negative, but perhaps  simply less negative than today, and why not slightly positive if fiscal policy became supportive. Yield curve steepening could be the result, albeit not dramatically. But longer term, the setting has improved for the banks.

This and the perception that the ECB might be done has been positive for the euro. Where initially the single currency dropped versus the US Dollar, it rose again afterwards. And the US Federal Reserve is the next central bank to cut rates now. While there is absolute certainty about a 25 bps rate cut next week, some argue 50 bps is not excluded. Such a bold move combined with dovish talk could clearly underpin the euro.