“Super Mario” expected to show off his muscles…

Brian Tomlinson
Written by

22nd February 2016

Can the ECB do more? Absolutely YES!

But…Mario Draghi will need to strike hard this time in order to stop the slide in inflation expectations, and to weaken the Euro which has risen from 1.08 to 1.13. The ECB can NOT afford to underwhelm and disappoint market participants in terms of its next policy actions.
Why?
The market is already pricing in a minimum of a further 0.2% cut in the deposit rate by the ECB (European Central Bank) at its next meeting on March 10th from -0.3% to -0.5%. A disappointed market would drive yields higher, which would mechanically make the Euro rise…which the ECB wants to avoid.


German 2-Year Government Bond Yield: -0.5%
German 2 year govt bond yield

Source: Bloomberg, AllianzGI, as of February 2016.
Past performance is not a reliable indicator of future results.

What’s more, market participants’ expectations for inflation are lower now than when the ECB launched its Q.E. (Quantitative Easing) program nearly 1 year ago. Euro area inflation, as measured by the 5 year 5 year inflation swap (which is what the ECB focuses on), is at 1.45% and on a declining path.

Inflation expectations are declining
Inflation-expectations-are-declining
Source: Bloomberg, AllianzGI, as of February 2016
Past performance is not a reliable indicator of future results.

So what can the ECB do to raise inflation expectations and weaken the Euro in order to increase European exports and create export-related jobs?

The ECB needs to “L I E”… Lower, Increase and Extend!
1. Lower the deposit rate from -0.30% to -0.75 %, to weaken the Euro.
2. Increase the size of its monthly purchases of European government bonds from Euro 60 billion to Euro 100 billion. This would increase the supply of Euros, and ceteris paribus weaken the Euro.
3. Increase the percentage of peripheral bond purchases to lower the borrowing costs of peripheral countries, namely Portugal, Spain, and Italy.
4. Extend the duration of the Q.E. program from March 2017 to September 2017.

The ECB chief Mario Draghi (Super Mario) has an impeccable and outstanding track record of delivering exactly what he communicates, and also, when necessary, exceeding market participants’ expectations. Get ready for the show of force on March 10th!

All sources unless stated otherwise Allianz Global Investors 17/02/2016.

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.

Past performance is not a reliable indicator of future results.

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