Commodity Rout Pushes Bets on ECB Policy Normalization Back by a Year
London. A slump in commodities prices over the past month has pushed back expectations of when the European Central Bank will start normalizing its ultra-loose monetary policy by a whole year, to 2019.
Growth concerns in China, which accounts for almost half of global copper demand and 70 percent of iron ore consumption, have sent commodity prices tumbling in recent weeks.
The Thomson Reuters Commodities Research Bureau index slid 10 percent in July to its lowest levels since early 2009, when the world economy was mired in crisis and recession. Copper fell to six-year lows this week while oil also dipped close to its lowest in four months.
Such developments have reverberations across the world, hitting inflation and growth expectations. In the euro zone, the ECB’s preferred measure of the market’s inflation expectations fell to its lowest in nearly two months.
Accordingly, money markets see a heightened policy response. The ECB is now expected to marginally lift rates in four years, compared with three years a month ago.
Any delay in moves by the ECB to normalize the policy might be preceded by an extension of its trillion euro bond-buying program, due to end next year, traders and strategists say.
The quantitative easing (QE) scheme, was launched in March with a September 2016 end date, although the ECB has kept an open mind about its size and scope from the beginning.
“This surprise reaction is due to the fact that commodity prices have fallen quite markedly,” said Cyril Regnat, fixed income strategist at Natixis, referring to money market moves.
“We have these expectations of lower demand from China and … that leads to lower inflation expectations in Europe. The market is pricing in an extension of the current QE program.”
The International Monetary Fund warned on Monday that euro zone growth prospects were modest and urged the ECB to keep its money presses rolling.
With spot Eonia rates at about -0.11 percent, the zero level on the forward curve is widely considered the point at which the market is pricing in a rate hike, as it is assumed that any such move would reverse the ECB’s last rate cut, which was by 10 basis points.
Four-year Eonia rates are now zero. A month ago, it was three-year rates that traded at zero.
The speed with which the ECB hikes rates thereafter is also seen slowing. Ten-year Eonia rates have fallen to about 0.75 percent from roughly 1 percent a month ago.
When banks have plenty of cash beyond what they need for day-to-day operations, as at present, Eonia rates usually stabilize at slightly less than 10 basis points above the ECB’s deposit rate, now set at -0.20 percent, and there is no indication this floor would be lowered further.
Excess liquidity in the euro system stands above 400 billion euros. Historically it has only had a notable impact on money market rates when it was below 100 billion.
Therefore it cannot be assumed that money markets are pricing in more QE. But this is what the market talks about.
“I recall that early on in the year we had discussions about tapering QE earlier now we talk about it being extended,” said Benjamin Schroeder, rate strategist at Commerzbank.
“Overall I think it is more likely it would be lengthened than shortened and the market has moved in that direction.”
The picture remains brighter than in March-April, however, when deflation fears meant the ECB was not expected to raise rates for six years.
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