ECB & QE Expectations
Our base case of a likely two-quarter ECB QE extension with no taper signal should be EUR neutral as it would partly keep concerns about Italy at bay. Under current circumstances, QE tapering may be tricky for EUR if higher EZ yields are offset by a rise in EUR risk premium (due to concerns about Italian banks). But whether it is the higher EZ yields channel or the EUR risk premium channel that dominates, being short PLN and HUF should be the desirable strategy under a QE taper scenario.
We expect the ECB to: (1) extend the QE programme by two more quarters at the current €80bn per month pace; and (2) change the modalities of the programme (options include increasing the issuer and issue limit on nonCAC bonds, dropping the deposit floor limit on purchases under the PSPP programme). Despite the recent emergence of speculation regarding QE tapering (as per a Reuters article last week), we believe this looks less likely at his point following the outcome of the Italian referendum and the market’s focus on the Italian banking sector. EUR reaction under no QE base-case tapering – muted Should the ECB extend the QE programme at the existing pace by two more quarters (our base case) its impact on EUR should be limited as: (1) this outcome is widely expected; and (2) there may be a muted increase in the EZ periphery credit risk premium (though equally no meaningful decline given concern about recapitalisation of Italian banks). EUR reaction under QE taper alternative case scenario – rather tricky Under current circumstances, EUR reaction may be tricky should the ECB opt for tapering this week and be determined by: (1) the scale of German bunds/EZ bond yield increase (EUR positive); and (2) the extent to which higher EZ yields will lead to concerns about peripheral countries, spread widening and EUR risk premium rise (EUR negative). Following the Italian referendum, markets seem to have priced in a glass half full view and further ECB QE support. This is reflected in the muted reaction in BTP spreads and decline in EUR/USD volatility premia (Figure 1). Should the QE taper announcement lead to peripheral spread widening and rise in EZ risk premium (risk of which does not seem to be priced in), there is a risk that this may offset the effect of higher bund yields on EUR.