Expect ECB to prolong the QE purchases beyond March 2017 – Danske Bank

Chief Analyst, Arne Lohmann Rasmussen at Danske Bank, notes that the Eurozone GDP growth showed strength by increasing to 0.6% q/q in Q1 16.

Key Quotes

“The solid growth was mainly driven by private consumption supported by the low oil price and the decline in the unemployment rate to 10.2 % in April - its lowest level since 2011. The rising oil price is expected to dampen private consumption somewhat but the continued improvement in the labour market should still be supportive.

We further expect investment growth to pick up pace in the second half of 2016 after the UK referendum (we expect that the UK will remain in the EU), as uncertainty is fades which together with increasing domestic and foreign demand and very low costs of borrowing should release some of the pent-up demand for investments.

Headline inflation increased slightly from -0.2% y/y in April to -0.1% y/y in May while core inflation was also up 0.1pp to 0.8% y/y in May. In the coming months, we expect headline inflation to rise sharply supported by base effects related to the oil price increase. However, this is mainly driven by a temporary support from the oil prices and the ECB should not yet conclude that inflation is on a sustainable path towards 2%. We still believe that the ECB is too optimistic in its outlook for core inflation.

Based on the inflation path described above, we expect the ECB to prolong the QE purchases beyond March 2017. However, in the near term and during the summer, the ECB should remain in implementation mode, which was confirmed at the last meeting. Draghi repeated that additional monetary policy easing from measures already announced will follow when implemented and added that the ECB’s policies are working but that the full impact from the measures taken in late 2015 and in Q1 16 is not visible yet.

The current easing measures from the ECB and our view that the ECB will prolong the QE purchases mean that any significant rise in EUR yields now looks quite unlikely and further downward pressure in the next couple of months should certainly not be ruled out.

Given the current ECB measures, there is a possibility that German bond yields could approach those of Japan and Switzerland. Especially, if - contrary to our expectations – there is a ‘Brexit’. However, we still see modest upward pressure on a six to 12-month horizon, as we still expect upward pressure on the long end of US yields in 2017.

We still firmly believe that the ECB will be able to keep 2Y and 5Y yields in check with QE purchases and a deposit rate at -0.4%. Thus, we still look for a modest steepening of the EUR curve for 2Y10Y and 5Y10Y. Additionally, we expect 3M Euribor fixings to stay below zero throughout the forecast horizon.”