Draghi Seen Unflinching on Turbulence With QE Holding Steady

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Mario Draghi has convinced economists that he won’t come to the aid of the bond market any time soon.

Ninety-seven percent of respondents in a Bloomberg survey predicted the European Central Bank won’t take action to stem falling bond prices, after the ECB president said this month that investors must get used to more volatility. Draghi may face questions on the risks that poses for the economy, as well as being quizzed on Greece as the nation edges toward a possible exit from the euro, when he testifies before the European parliament on Monday.

Three months into the ECB’s 1.1 trillion-euro ($1.2 trillion) quantitative-easing program, sovereign bonds are slumping as inflation expectations return. While the consequent rise in yields could increase borrowing costs for companies and households, ECB policy makers have lined up to say they see no reason to step in.

“The question is, what can they do if interest rates rise further on a broad-based scale when the central bank already purchases bonds?” said Duncan de Vries, an economist at NIBC Bank NV in The Hague. “Moreover, the ECB probably doesn’t feel the urgency to act at current yield levels, especially not as it’s anticipating higher market volatility. Steady as it goes is the message for the time being.”

Hands-Off Approach

The bond slump marks a reversal from the start of QE, when debt prices rose so high that many sovereign bonds had negative yields. Draghi’s hands-off approach to the matter has been endorsed by ECB officials including Bundesbank President Jens Weidmann and Ewald Nowotny, the head of Austria’s central bank, who say higher yields reflect a recovering economy.

Executive Board member Benoit Coeure said volatile markets are only a concern if they pose a risk to the ECB’s goal of returning inflation to just under 2 percent. Inflation was 0.3 percent in May, the first positive rate in six months.

“The ECB does not intend to counter that volatility in the short term, which would effectively give market participants a free insurance policy,” he said last week. “However, we will not allow excessive fluctuations in financial markets to threaten the achievement of our objective.”

The ECB’s message that it will stay the course on QE seems to have got through to economists. In the Bloomberg survey, 68 percent of respondents said the central bank will reach its bond-buying target of 60 billion euros every month through September 2016, slightly up from the previous survey in April.

Tapering Schedule

When the time comes to end the program, 78 percent said the ECB will taper purchases rather than cutting them off in one go. That compares with 56 percent in the previous survey.

Predicted start dates for any winding down ranged from November 2015 to January 2017, with 65 percent saying it won’t begin before September 2016. The median estimate for the duration of tapering was six months.

“The relatively small size of the asset-purchase program makes tapering it unnecessary,” said Alasdair Cavalla, an economist at the Center for Economics and Business Research in London. “Nevertheless, caution will probably prevail.”

Economists shared Draghi’s concern, expressed at his press conference on June 3, that there is a “slight loss of momentum” in the euro-area recovery, mostly as a consequence of weaker economic prospects in the rest of the world.

Greek Shock

Just 31 percent of respondents said the economy of the 19-nation currency bloc will improve over the next six weeks, compared with 67 percent in the April survey.

Risks include an easing of the tailwinds that drove the recovery such as a weaker euro and cheaper oil -- as well as the sentiment-sapping Greek crisis. European stocks slid and the euro declined on Monday after weekend talks between Greece and its creditors collapsed. The yield on Greek 10-year debt was up 71 basis points at 12.47 percent at 1:43 p.m. Frankfurt time.

Negotiations to find a way to unlock bailout funds failed after just 45 minutes on Sunday, leaving Greece closer to a debt default. The talks were a “last attempt” by European Commission President Jean-Claude Juncker to reach a compromise before finance ministers meet on June 18, the commission said. He worked in “close liaison” with the ECB and International Monetary Fund.

The ECB, which is keeping Greek lenders afloat by authorizing the Greek central bank to issue 83 billion euros of emergency liquidity, must be on board with any deal. It would also play a key role in coordinating any Greek exit from the currency bloc and managing the consequences for the region’s financial system.

“Grexit will severely damage the euro and send peripheral yields much higher,” Alastair Winter, chief economist at Daniel Stewart & Co. in London, said in the survey. “Economic recovery will be very slow.”

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