The timing of the release of the ECB’s Financial Stability Review yesterday was apt – coming on a day when Bitcoin fell a further 30% intra-day. Apt timing because the European Central Bank (ECB) warned of “remarkable exuberance” in the financial markets and a “clustering of risks in some sectors and countries”. So what might this mean for the markets ahead? Derek Halpenny, Head of Research, Global Markets EMEA & International Securities at MUFG Bank, lays out three possible consequences.
Financial Stability Review reinforces risk-off
“If there are concerns over exuberance in the markets, it is logical for the markets to then assume the prospects of a slowdown in PEPP purchases when the quarterly reassessment takes place at the June meeting are greater. The current rise in yields across debt markets is in anticipation of a slowdown in the pace of PEPP purchases being the outcome of the reassessment and the Financial Stability Review in our view will only reinforce those building expectations.”
“Bloomberg reported last week that banks in the eurozone are lobbying the ECB to extend the exclusion of bank deposits held at the ECB from leverage ratio calculations. The Fed has already allowed its temporary leverage relief ratio measures to expire and following the concerns expressed in the Financial Stability Review, the ECB looks like it will follow. This factor would not have euro implications like a slowdown of PEPP purchases but would reinforce the perception of greater focus on attention turning to excessively loose financial market conditions, which indirectly would be more EUR supportive.”
“Financial market exuberance as viewed by the ECB, if sustained, could play into the conclusions of the ECB’s monetary policy review. It could lean the ECB more toward a more cautious change in strategy. At a minimum, the ECB is likely to remove the symmetric bias to the downside in the current price stability definition – ‘close to, but below 2.0%’. We doubt that will impress the markets but the ECB may view an average inflation targeting regime as more risky at a time when inflation concerns are rising. A more cautious conclusion to the monetary policy review would add to EUR support.”
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