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Nick Kounis, an analyst at ABN AMRO, explained that this week’s ECB Governing Council meeting will be watched for further clarity on two issues.  

Key Quotes:

“First of all, whether ECB President Draghi will provide any further signals on the precise meaning of the ECB’s forward guidance on how long interest rates would remain at current levels, as set out in June. Since that meeting ‘through the summer’ has been communicated by some Governing Council members as being during the summer, others as September and others as beyond September.”

“Our own view is that given the guidance and subdued inflationary pressures, the ECB is unlikely to hike before December 2019. The second issue concerns the policy with regards to reinvestments. The ECB did not amend its forward guidance on reinvestments in June, suggesting that there was still a lot to discuss and agree to in the other policy areas. So a change in the guidance might be on the way.”

“The ECB could well change the current guidance of maintaining reinvestments ‘for an extended period of time after the end of our net asset purchases’ to ‘for an extended period of time after the first adjustment in interest rates’. As such, it would signal that reinvestments will not end until 2020 at the earliest.”

“Meanwhile, there have been reports recently that the ECB was considering skewing its reinvestments of redeeming securities under the PSPP to longer-dated securities. We expect  Mr.  Draghi to play down such speculation. NCB holdings of core bonds will be at – or very close to – the issuer limit later this year so re-investments will be allocated in line with the maturity buckets issued by national debt agencies. NCB holdings of Italian, French and Belgian bonds will still be below the issuer limit, so those NCBs would have more room to lengthen the tenor of reinvestments. However, the policy of market neutrality will be a constraining factor.”  

“If market expectations move towards our base case for policy rates and reinvestments, we would expect 2s5s and 2s10s to flatten over the next few months, 10s30s to steepen, and the euro to weaken.”