Today, all focus will also be on the long-awaited ECB meeting. We expect the ECB to announce a six-month extension of its QE programme and maintain monthly purchases at EUR80bn. This is probably close to market expectations given a recent Bloomberg survey, where 64% of analysts expected a QE extension with the current pace kept unchanged.
The market used yesterday to position itself for Draghi today and we saw a relatively strong rally in the European government bond market as both periphery and core yields were pushed lower. Especially, periphery bonds performed, also helped by the strong risk sentiment. Italian 10Y bond yields dropped another 6bp and are now down 16bp since the initial opening on Monday morning.
However, especially Italy might be exposed today if the ECB disappoints the market, given the political uncertainty and change in the rating outlook from Moody’s late last night. The rating agency changed the outlook on Italy’s ‘Baa2’ long-term issuer rating to negative from stable. Moody’s affirmed Italy’s long-term senior unsecured government bond rating at ‘Baa2’ and its short-term commercial paper rating at P-2. The rating agency motivated its decision with two specific drivers: (1) the slow and halting progress on economic and fiscal reform in Italy, the prospects for which have diminished further following the ‘no’ vote in Sunday’s constitutional referendum; and (2) the resulting rising risk that the reduction in Italy’s large debt burden will be further postponed.
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The equity markets also took an early celebration of more stimuli from the ECB and the major indices in both Europe and the US saw healthy gains and new all-time highs were seen in Dow Jones and S&P 500. Despite the drop in European yields ahead of the ECB meeting, the euro performed and EUR/USD was trading at 1.078 after trading briefly below 1.055 on Monday morning. The Swedish krona also got a boost after the Riksbank’s member Per Jansson, who is normally quite dovish, said that there are ‘limits to monetary policy’. EUR/SEK dropped to 9.76 during the day. This morning, Japan released updated Q3 GDP numbers and growth was somewhat surprisingly revised from an initial 2.2% q/q annualised to 1.3% q/q annualised as business spending was weaker than initially expected.
As we have flagged this week, we expect the ECB to come out on the dovish side (prolonging the QE programme by six months) and hence provide some downward pressure on the EUR/USD. However, if Draghi is perceived to be fairly hawkish by mentioning tapering, then we could see quite a violent upward move in the EUR/USD given that the market is almost stretched short the EUR.
