The European Central Bank’s (ECB) governing council meets on Thursday 14 June. While no decisions are expected on interest rates, markets will be watching for commentary surrounding the gradual withdrawal of quantitative easing. The current monthly pace of €30bn net asset purchases are intended to run until the end of September.
Last week, governing council member Peter Praet indicated that the central bank was pleased with the rise in inflation in the eurozone and suggested the central bank would be mulling a gradual unwinding of net purchases, based on underlying strength in the economy and pass-through to wage and price formations.
Eurozone inflation was 1.9% in May up from 1.2% in April, while GDP growth was 0.4% in Q1, according to Eurostat.
Chris Godding, chief investment officer at Tilney, said there was still a risk that the ECB could adopt a more hawkish tone because of the election of a populist eurosceptic government in Italy that looks likely to sharply increase government spending. “The fiscal impulse in Italy could have an effect on the ECB,” he said.
“The ECB certainly has form when it comes to gradualism and the data so far this year suggests that there is no rush to tighten. However, they will need to recalculate their policies if Italy ignores the fiscal rules and injects significant additional stimulus,” he says.
Architas’ investment director Adrian Lowcock also believes that the political situation in Italy will have an impact. “It will no doubt be a factor but not necessarily a deciding one,” he said.
Forward guidance
However, Darius McDermott, managing director at Chelsea Financial Services, says there is no evidence yet that what is happening in Italy will change the ECB’s plans. ECB governing council member Praet’s comments – that the rise in inflation suggested the central bank would be mull a gradual unwinding of net purchases – was just a bit of forward guidance to manage expectations, McDermott said.
“[The ECB] already owns about 14% of Italian sovereign bonds and will probably remain a steady buyer. I don’t think we will see rate rises in Europe because of the Italian situation.”
Moreover, Italy is unlikely to leave the EU, McDermott said.
“All the data points to the fact that most Italians feel more European in the UK, so even if they had a referendum – which at the moment is not allowed in the constitution – the result is unlikely to be ‘leave’.”
Meanwhile, Stefan Isaacs, deputy head of retail fixed interest at M&G Investments, said that the ECB will take a gradual approach but was be unlikely to have “sufficient firepower” to feel confident that it can stimulate the eurozone economy before the end of the economic cycle.
“Further rate cuts from here will probably do more harm than good,” Isaacs added.
Radically different
Juan Valenzuela, co-manager of the Kames Strategic Bond Fund, said the Italian situation was radically different from the eurozone debt crisis between 2010 and 2012.
Valenzuela said: “The ECB is unlikely to react to an increase in risk premium derived from fiscal prodigality that is against European laws or the unwinding of the limited structural measures approved by previous governments.
“Financial stability concerns would eventually justify a response, but we appear to be far from this point. Therefore, we still expect the ECB to be on course to conclude its monthly purchases towards the end of the year.”
McDermott said investors are still likely to see further volatility in Italian government bonds.
However, he added that unless investors have a strong view on direction of travel, the volatility will act as an opportunity “to make small top ups to your European bond holdings.”
