More ECB baby steps

The euro slid below $1.3 on Thursday, as a reaction to the combination of strong US macro data and the ECB announcing that they will be buying asset-backed securities, typically mortgages and small business loans. Alongside this they reduced interest rates marginally and further lowered deposit rates. This announcement came with the news that the ECB will cut growth forecasts in the eurozone to 0.9% for 2014. In our view lowering deposit from -10 basis points to -20 basis points and shaving 10 basis points off interest rates in the eurozone will probably have a negligible effect. Purchasing asset-backed securities, depending on the size of the program, will probably have more of an impact. The purchase of asset-backed securities will start in October, just as the Federal Reserve wind up their bond-buying program.

The ECB's announcement led to a further fall in euro zone bond yields and a rise in European equities. Spanish 10-year bonds now yield 2.16%, which not so long ago were at 6%. This continued fall in peripheral bond yields has dragged US treasury yields lower with it. One has to wonder how much further yields can fall and with an improving US economy perhaps the Bull Run in bonds this year may be coming to an end.

Unsurprisingly, the reaction from the S&P 500 and the FTSE 100 was slightly more muted. Mario Draghi and the ECB did not state how big the asset-backed purchases were to be, but he did say that he wants to return the ECB balance sheet to its size in 2012, that would see it increase by 1 trillion euros. It would appear that the ECB continue to take baby steps towards the inevitability of introducing their own form of quantitative easing.

Today's efforts, irrespective on their impact on the overall economy should continue to ensure that quality risk assets will attract capital, which must be one of the desired effects. With deposit rates falling further into negative territory, Spanish 10-year bonds offering a little over 2%, and inflation hovering just above 0, blue chip equities offering yields in excess of 3% should continue to attract capital.

One quick word on UK interest rates, which remained unchanged at 0.5%, the curiosity will be in the release of the minutes from the meeting and whether the two rebels from the last meeting have drawn more to the cause. Sterling continues to lose ground to the US dollar; this looks like more to do with continued dollar strength than sterling weakness. This move in sterling should see a boost to all those exporters who complained bitterly about its strength a few weeks ago.

Posted on September 5, 2014 .