Last Thursday Mario Draghi did not let the market know what he plans to do regarding tapering of the ECB’s bond buying program. Instead, he postponed the decision to the October meeting.
Am I surprised? Not really. It was the only plausible thing for him to do, considering the German elections are taking place on the 24th of September. Draghi is playing for time. With the elections out of the way and another month of economic data, the ECB would be able to decide what its next decision will be.
What is 'tapering'
Tapering is the gradual winding down of central bank activities used to improve the conditions for economic growth. Tapering activities are primarily aimed at interest rates and at the management of investor expectations regarding what those rates will be in the future. These can include changes to conventional central bank activities, such as adjusting the discount rate or reserve requirements, or more unconventional ones, such as quantitative easing (QE).
What is the ECB’s current buyback program?
The ECB is currently buying €60bln worth of bonds every month with the scope of increasing liquidity in the European economy, and getting people to spend more in the hope of boosting inflation.
This program will continue until the end of 2017. If tapering is announced, it will happen beginning 2018.
Will tapering be delayed?
The market is betting on the ECB announcing tapering in its next meeting. Just look at the EURUSD. It shot up above the $1.20 level after the September ECB meeting.
However, I believe there is a good reason to delay. The return to growth is not firmly established. And despite an ECB balance sheet of over €4 trillion, core inflation has only managed to accelerate from 0.9% to just 1.2%.
That is not exactly encouraging hope of a sustained pickup in consumer prices that will drive the key rate to the target of just below 2% and keep it there.
After all the drama around the Italian, French and Dutch votes, letting this one sort itself out first makes sense.
The arguments in favour of tapering - ECB revised its growth forecasts
The ECB revised up its growth forecasts, predicting 2.2% this year, 1.8% in 2018 and 1.7% in 2019. In June, it expected growth of 1.9% this year, 1.8% in 2018 and 1.7% in 2019.
The arguments against tapering - inflation forecasts downgraded
The stronger euro has caused the ECB to revise downwards its inflation forecasts. It now expects inflation of 1.5% this year, 1.2% in 2018 and 1.5% in 2019, below the ECB’s target of almost 2%.
In June, inflation was expected to hit 1.5% this year, 1.3% in 2018 and 1.6% the following year.
Markets are betting on tapering to be announced by the ECB in October
Mr Draghi said the ECB expected to take the “bulk of decisions” on tapering at its meeting in October. Despite talking about the strengthening euro as a “source of uncertainty”, his comment lifted the euro to a new high for the day, reaching $1.2033.
Conclusion
What is certain is that we are seeing economic growth improvement, and inflation is coming back. This is a positive for equities.
Despite equity markets rallying strongly, I believe that there is still value out there. A well-diversified portfolio, which is focused on sectors that are expected to outperform in the current environment, should continue to reap rewards from the equity market.
My view is that the rally in the equity markets will continue, it is currently a bull market and in my opinion any weakness is still a buy!
Disclaimer: This article is issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.