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Bracing For Europe’s Reversal

10 March 2020 by jbchevrel

Today the market sentiment shifted upward on fiscal easing expectation, mostly in the US, but also in Italy. On the fiscal side of the equation, we will get the UK budget tomorrow. On the monetary side of the equation, we will get the ECB on Thursday. The consensus expects the ECB to lower interest rates by -10bp, after the recent stock market moves and heightened concerns about the COVID19 spread. The whole of Italy is now being placed into lock down. That being said, I think that at this juncture (depo rate -50bp), a -10bp further cut will have a limited effect. Also, a few members of the GC have been talking about the “reversal rate”. This is the rate at which lower rates encourage commercial banks to reduce, rather than increase, lending to the real economy, making it look quite counter-productive. Neither Lagarde nor Schnabel seem to believe that the reversal rate has already been hit. More importantly, the consensus expects the ECB to put together a package aimed at targeted stimulus, notably to provide additional liquidity to the banking system and support SMEs. As there seems to be an aversion among some of the GC to further loosen via APP (this is close to requiring a relaxation of the issue and issuer limits). The ECB already owns c€2.6T of EGBs. Some analysts argue that there may be that additional QE eventually required on top of the €20B/month that the ECB is currently buying, something that might be best targeted towards corporate bonds. At least CSPP looks like the easiest sub-programme to grow APP, as opposed to PSPP and others. Not sure whether this could be announced as soon as this week, though.