ECB Preview: Will Recent Italian Developments Influence Europe’s Tapering Timeline?

The future of the European Central Bank’s three-year-old quantitative easing program lies in the balance. Will the bank’s governing council use its scheduled June meeting to extend the program or confirm that asset purchases will end in September? David Zahn, Franklin Templeton’s head of European Fixed Income, believes recent European economic data and political developments in Italy point towards an extension. And he argues that means eurozone interest-rate hikes are unlikely before 2020.

The European Central Bank (ECB) started its quantitative easing (QE) program in March 2015, and later this month we finally expect some concrete details on a timeline for wrapping it up.

Officially, QE is due to end in September this year, but with eurozone growth data softer recently and inflation also relatively muted, we think it would be premature for the ECB to embark on a tightening cycle.

So our expectation is that current ECB President Mario Draghi will extend the asset-buying program at least to the end of this year and most likely into 2019.

With further tapering possible, we believe the purchase program will lean even more towards private assets, such as corporate bonds, as the ECB continues down the path of reducing government bond buying.

A continued focus on corporate bonds should also help maintain narrow credit spreads, while government purchases can continue to be reduced.

Italian Situation Adds to Europe’s Risk Premia

Meanwhile, political developments in Italy, in particular, have contributed to a general widening of risk premia in Europe.

Since the League and Five Star Movement have successfully formed a government, we expect a loosening of purse strings in Italy. The bond market has already reacted negatively to this possibility. But we don’t think this is a systemic issue; rather, it’s a case of assessing what risk premia should be added to Italy given its likely new fiscal focus.