Markets Hope ECB Easing Package Could Be a Big One

The European Central Bank sent a strong signal Thursday that a package of easing measures is coming in September. Recent emphasis from President Mario Draghi that the central bank would tolerate higher inflation has some investors betting the effort is going to be aggressive.

Investors initially cheered the news that the ECB is looking at cutting rates deeper into negative territory, while offering some relief to banks and restarting its bond-buying program. Germany’s 10-year government bond yield hit a record low of minus-0.461%. Similarly, the euro also fell to its lowest level in more than two years at $1.104. These moves reversed somewhat later Thursday as it became clear that there are few details on the stimulus package for now.

“The ECB looks likely to launch a very comprehensive package of measures in September, using unprecedented language about inflation expectations and their inflation mandate in particular,” said Frederik Ducrozet, strategist at Pictet Wealth Management.

For the first time as part of an official policy statement, Mr. Draghi said that the ECB would aim to overshoot its inflation target of “below but close to 2%” in the near term to make up for inflation that has run persistently far below target. With the central bank showing it is less concerned about stoking inflation, it can be more aggressive with its measures.

“Symmetry means there is no 2% cap, inflation can deviate on both sides and we don’t accept permanently lower inflation rates,” Mr. Draghi told journalists.

In the near term, the ECB’s signals of a big package of measures could put pressure on the Federal Reserve to cut rates by more than the quarter-percentage-point widely expected next week.

Ken Wattret, chief European economist at IHS Markit, said the ECB’s coming package might incline the Fed toward a bigger move. But the U.S. central bank ought to be focused more on domestic economic developments. Although he added that given the Fed’s expected cut is seen more as insurance against a downturn rather than a needed stimulus, it might now face less pressure.

The idea that the ECB is going to take action “could be interpreted as a reassurance and therefore may argue for less radical Fed action rather than more,” he said.

Investors are watching for what focus the next bond-buying program will take. Mr. Draghi said that committees had been tasked with examining options on the size and composition of a potential new asset-purchase program, known broadly as quantitative easing. One sure result is further additions to the world’s $13 trillion of negative-yielding bonds: Expectations of a program have helped European government-bond rates fall to record lows.

“More negative government-bonds yields will push investors into peripheral bond markets, corporate and high-yield bonds,” said Gareth Isaac, chief investment officer for fixed income in Europe at Invesco.

Another fresh measure could be a system of relief on the charges that banks have to pay to keep reserves at the central bank in a negative-rate world.

Under tiering, less-painful rates would be charged on some reserve deposits. That is meant to limit the damage to bank profitability that further rate cuts by the ECB could cause. This measure, along with the promise of the wider stimulus, is what helped bank stocks to rally, but the lack of real detail led some investors to cash out of profitable trades during the day.

“The price action is more about profit-taking and the fact that Mr. Draghi offered little detail on what is coming in September,” said Salman Ahmed, chief investment strategist at Lombard Odier IM. “On QE, I expect a heavier focus on corporate bonds and that’s where I see value during the hot summer, not core euro government bonds.”

Some observers remain skeptical that the measures will be enough to recharge the economy. Ed Parks, deputy chief investment officer at U.K. fund manager Brooks Macdonald, said he remains underweight European equities and other risk assets because the economic data looks poor.

“We think the market is still pretty disappointed about what can be delivered,” he said. “We’ve been skeptical for some time about how much the ECB can do on deposit rates and QE. And [Wednesday’s policy-decision meeting] was never going to be the big meeting. It’s a placeholder for September.”

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