ECB's December Meeting

No rabbit our of the hat

Yesterday, the ECB clearly disappointed the markets. Indeed, Mario Draghi cut the deposit rate by only 10bp, and extended the Public Sector Purchase Programme (PSPP) duration until March 2017 only.

Draghi also underlined that, although the decision was "not" unanimous, "a large majority was in favour of the package."

That Mario Draghi has refrained from more radical measures (such as changing the conditions of the PSPP and/or introducing a deposit rate scale regime) also confirms that political sensitivities will likely prevent the ECB from doing so in the future.

Following the ECB decisions, the market overreacted significantly, leading to a stronger euro, higher bond yields and lower stock prices.

Economy:

• Macroeconomic developments, which have been surprising slightly on the upside over the last two months for the euro area, may have played a role in the Governing Council's decision against more aggressive monetary accommodation in December, with President Draghi quoting the success of the extraordinary monetary policy measures implemented so far, and which have resulted in:
  • An improvement in bank lending conditions;
  • Narrowed spreads between large firms and SMEs;
  • A compression of spreads between lending rates in vulnerable countries vs. core countries.
• The December ECB meeting’s staff growth projections – 1.7% for 2016 and 1.9% for 2017 – were largely on a par with September’s figures.
• The ECB cut inflation estimates to 0.1% for 2015, 1.0% for 2016 and 1.6% for 2017 from 1.7% previously. They also mentioned that risks remained on the downside and were largely linked to geopolitical events and commodity prices.
• The ECB underlined its commitment to use all available instruments to ensure that the Euro-area recovery consolidates and inflation returns to close to, but below, the 2% target.

Impact on our money market fund range

Liquidity & Rate

The extension of the PSPP until March 2017 will not change the liquidity excess increase path, since the monthly amount has remained unchanged. We expect a liquidity excess of around EUR 650 bn year-end, and around EUR 1 700 bn by March 2017.

However, on the rate side, a 10 bp cut on the deposit rate will plunge the EONIA deeper into negative territory. Theoretically, the EONIA will lower to a level between -0.25% and -0.23%.

However, with the decrease in the volume traded, we could expect the EONIA to be a bit higher, and stay between -0.20% and -0.15%.

The Euribor followed the same path. The EURIBOR 3-month is now at -0.124%, and the EURIBOR 6-month at -0.051%.

ECB measures and credit impact

The ECB widened the corridor between the refinancing rate and the deposit rate and could penalize further big banks that have heavy cash-on-deposit accounts. In this new galaxy of rates, the banks will be encouraged to have less excess liquidity and provide a greater lending supply to the real economy. In other words, these measures have highlighted the ECB’s willingness to support a gradual macroeconomic recovery in Europe.

CONCLUSION

One thing is certain: monetary policy is and will remain accommodative for as long as necessary.

Although a more negative deposit rate could, on the one hand, help the economy, it could also, on the other hand, put the financial institutions (Banks, and Insurances) in a more challenging position by improving their cash management capabilities.

Our funds are geared in this direction to outperform our benchmark under such market conditions:

• Overweight Credit and the search for higher-yielding issuers (with a minimum short-term rating of A2/P2);
• Optimal duration allocation on longer maturities.

Pierre Boyer
Head of Money Market Fund Management