Rates Spark: First QE Taper Of 2020

The BOE's updated QE target implies a reduction in the pace of Gilt purchases. They should still roughly match Gilt issuance but GBP rates volatility should increase with a less dovish central bank. Large TLTRO take-up, especially in the periphery, will cement expectations of lower Euribor fixings, especially for longer tenors.

Source: BOE, DMO, ING

The BOE tapers unexpectedly

The BOE yesterday bucked the trend of other central banks over-delivering on easing expectations, and in particular on balance sheet expansion. At first glance, the £100bn QE increase was in line with market expectations but the MPC stressed that it intends this amount to cover purchases until the end of the year. Compared to the pace of purchases since March, this implies a significant tapering of balance sheet expansion. It should be said that the bank left the door open to an acceleration of purchase should the outlook worsen, however. Our UK economist stressed that negative rates are probably low on the list of tools favored by the BOE.

The reinvestment of two Gilts already owned by the BOE, which are neutral for the size of the portfolio, means the average pace of gross purchases should drop from £11bn/week in March-June to £7bn/week in June-December. The update to the Debt Management Office's (DMO) remit on June 29th takes on added importance for the direction of GBP rates. Using the deficit estimate in the Office for Budget Responsibility’s coronavirus assessment, we expect £193bn to be sold in August 2020 to March 2021 period, or a weekly pace of £5.6bn/week on average.

But we see no long-lasting divergence of GBP rates vs USD and EUR

The news hit the long-end of the GBP curve, with markets caught off guard by the announcement. The move was all the more noticeable in that USD and EUR yield curves were in the grip of a strong bull-flattening move as neither market has, unlike the UK’s, reasons to doubt their central bank’s resolve in suppressing interest rates. If our Gilt supply estimate is correct, the divergence of GBP rates from their USD and EUR counterparts should be limited thanks to BOE purchases still outweighing debt sales. The narrative of an ever-easing central bank took a hit however and realized volatility could prove to be persistently higher.

Large and widespread TLTRO participation should add to improved risk sentiment

Banks took up €1.3tn in the TLTROIII.4 yesterday, resulting in a net liquidity injection of €548bn when taking into account voluntary repayments and other maturities. In particular, the widespread participation of 742 banks in the operation should add to the positive sentiment with the new liquidity buffer further reducing systemic risks. Together with the ECB's asset purchase envelopes which will be spent until mid next year, excess liquidity in the banking system will continue to increase over the next 12 months, from around €2.7tn once yesterday's TLTRO has settled towards topping €4tn.

One should keep in mind that all outstanding TLTROIII tranches benefit from the more generous terms, i.e. €1.5tn in total. The rates charged can go as low as -1% in the first year if certain lending criteria have been met. This has opened up carry opportunities and some of the funds may initially be parked in short term assets such as bills or covered bonds. Tighter front end rates more generally could also translate into further tightening in Euribor-OIS spreads - or at least cement what has been achieved thus far. While in the shorter Euribor tenors the further downward dynamic could run out of steam as pre-crisis levels have almost been reached again, the longer tenors now stand to benefit.

More broadly, reports from large peripheral banks that they drew their max TLTRO allowance yesterday will be key in reducing perceived systemic risks in our view. This adds to the case for tighter sovereign spreads.

Longer tenor Euribor fixings prove more sticky

Source: EMMI, ING

Events today: EU council meeting

The Council of Europe meeting should be heavily focused on the European Recovery Fund. There is no breakthrough expected today but we might get a better idea of what concessions need to be made to placate the various factions.