This post is available in pdf format My weekly Column – Italy Standpoint – PW
What were last week’s major changes?
The main change was in Italy with a strong and rapid drop in the interest spread with Germany.
Since the new coalition government came to office, fears have emerged on exactly how the campaign-trail program would translate into the forthcoming budget – an answer to this question is expected on September 27.
The government’s stance so far has been to be fairly relaxed, especially on the 3% threshold (of budget deficit as % of GDP), which explains why the yield spread with Germany widened considerably over recent weeks.
This was a source of concern as the Italian economy would soon have run up against financing difficulties due to the reluctance of non-resident investors – who hold around 35% of the country’s debt – to revisit the Italian market after withdrawing their investment in the country all summer. Italians cannot and do not want to leave the euro area, so additional pressure on liquidity and interest rates could have hampered funding for Europe as a whole.
However, the economic situation is swiftly changing in Italy, as economic activity slowed sharply over the summer months, Continue reading
As expected the ECB has maintained the level of its three interest rates and reduced the size of its asset purchase programme (APP).
The refi rate is still at 0%, the deposit facility rate at -0.40% and the marginal lending facility rate at 0.25%. They will remain at this level way after the ECB will have stopped its asset purchase programme.
This latter has been reduced to EUR 30bn per month from January 2018 until September 2018 except if the profile of inflation doesn’t follow the trajectory as expected by the central bank. In that case the programme could be extended in size and/or duration. (that could be the case as the ECB forecast for the inflation rate is just 1.5% in 2019 (the core inflation rate is also expected at 1.5%). This is way below the target at close but below 2%)).
There are no changes in the forward guidance: 1 – the ECB keeps open the possibility to increase the amount purchased or to extend the period on which it purchases assets. 2- The interest rate will increase only way after the end of the asset purchase programme. It means that Draghi will not not necessarily hike interest rates before the end of his mandate in October 2019.
The ECB will reinvest all the proceeds of its portfolio. It will give details on the 12 month profile of these reinvestments when it will be necessary.
The ECB has not discussed the composition of its APP (between sovereign and corporate bonds) and Draghi said that the APP process was flexible enough to manage the technical constraints that can be faced (not enough bonds to buy in Germany). He didn’t go further in the discussion. (The ECB will be able to mix the APP and the reinvestment to manage the constraint)
The ECB is doing like the Fed: it doesn’t want to surprize investors by its decision. No one is surprised by the reduction in the level of the asset purchase programme. The question was on the amount and on the period. But the choice was limited as the ECB gave the open options in the minutes of its last meeting. Moreover speeches from ECB members were transparent on what they could do.
The main surprise is the stability of the forward guidance. Therefore the change in the APP level appears as a technical adjustment and not as a change in the monetary policy stance.
The ECB doesn’t want to tie its hands in the conduct of its monetary policy. It doesn’t want to create the possibility of divergent expectations on investors side. Therefore the forward guidance remains unchanged but this guidance can be changed by the ECB itself without investors pressure. The balance of strength is still on the ECB side and this will not change in coming months. We will still depend on what they want to say, not the reverse.