EUR: ECB policy expectations & Italian elections – MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the euro has recently benefitted from yields in the euro-zone rising by more than in the US as the two-year and ten-year German government bond yields have increased by around 12 and 27 basis points respectively so far this year.

Key Quotes

“The ongoing strengthening of the euro-zone economy and building evidence of a pick-up in inflation pressures is encouraging the adjustment higher in euro-zone yields. The ECB remains comfortable to maintain its current loose policy stance in the near-term which was strongly defended by President Draghi at their last meeting. However, it will come under increasing pressure to shift to a less dovish policy stance as the year progresses.”

“We expect the ECB to signal in the second half of the year that it intends to begin winding down their QE programme from next year which should offer more support for the euro later this year. Those expectations were supported by comments yesterday from ECB Executive Board member Lautenschlager who stated that she was “optimistic that we can soon turn to the question of an exit” given that “all the conditions for a stable rise in inflation exist”. She represents the more hawkish spectrum of thinking on the ECB which is unlikely to shared more broadly at this stage. It leaves us comfortable for now that ECB policy is unlikely to significantly challenge our outlook for a weak euro ahead of the upcoming elections in Europe during the first half of this year.”

“Upcoming elections in Europe could include early elections in Italy. The risk of early elections perhaps as soon as June was increased yesterday by the ruling of the Italian Constitutional court on the country’s electoral law for the Lower House. The Court watered down former PM Renzi’s reforms thereby making it less likely one party can secure a majority and thereby reducing the likelihood of a populist party coming into power. It remains to be seen if further adjustments are deemed required to reconcile the electoral laws between the Lower and Upper Houses. Heightened political risks have the potential to weaken the euro further in the coming months.”