We expect the ECB's QE programme to keep EUR government bond yields suppressed and to push periphery yields even lower. We do not think the QE effect has been fully priced in yet.
When assessing the impact, we distinguish between the 1) 'direct demand effect' and the 2) 'hot potato effect' .
The 'direct demand effect' is the obvious impact of the ECB's purchases. A new and big buyer will crowd out current government bond holders . We expect this to lead to portfolio re-balancing by investors, a weaker euro and higher credit supply.
On top of this, the higher excess liquidity and negative deposit rate will cause an indirect 'hot potato effect', as investors (banks) look for alternatives to placing their excess liquidity at negative rates with the ECB.
The banking system is a closed system that is 'borne' with a given amount of excess liquidity which at the end of each day has to be deposited at a negative rate with the ECB. Thus, there is no way of escaping the negative rate and the risk of getting 'burned' by negative yields is pushing investors further out the curve and into riskier assets. This effect will be strengthened by QE as excess liquidity increases.
These effects should strengthen economic activity and increase inflation, which should also be positively affected by a boost to confidence from the QE programme.
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