While typically uneventful, this morning the release of minutes from the ECB’s January 18-19 meeting prompted a spike in both French and Spanish bonds, with yields dropping between 6 and 8 bps after the ECB said that “limited and temporary deviations” from the capital key “were possible and inevitable.” As Bloomberg explains, the gains in these countries are due to their larger overall outstanding debt, as deviations from capital key suggests the ECB may end up buying a more bonds from these countries.
Specifically, this is what the ECB stated::
Regarding the implementation details on the Governing Council’s December decision to permit asset purchases below the DFR “to the extent necessary”, the choices outlined by Mr Cœuré were seen to primarily hinge on the relative weights to be given to the different criteria and restrictions attached to the APP. It was recalled that sticking to the issue and issuer limits had been assessed as most important in this regard. While significant weight was also placed on limiting deviations from the ECB’s capital key, it was also underlined that limited and temporary deviations were possible and inevitable. Thus, there was some room for a trade-off between relative deviations from the capital key across jurisdictions and limiting the extent of purchases below the DFR.
The result was immediate for both Spanish and French bonds:
In other minutes highlights, the ECB policy makers “widely agreed” to maintain stimulus at their latest meeting because “otherwise, recent encouraging developments in inflation expectations and the prospects for a sustained adjustment in inflation towards the Governing Council’s inflation aim could be put at risk.”
The minutes added that “members widely shared assessment” that “underlying inflation pressures had remained subdued and signs of a convincing upward trend were still lacking” and noted that there was “broad agreement” to look through higher headline inflation.”
It remains unclear at what level of broad headline inflation, the ECB will no longer “look through” suddenly surging prices.
Mario Draghi’s merry man also said that while the wage-setting calendar “could have a significant impact on wage dynamics looking ahead,” agreements staggered over time and with multi-year horizons suggest “that any second-round effects would unfold rather slowly.”
On the positive side, the ECB added that downside risks to growth outlook receded “somewhat,” risks surrounding scenario of gradually firming recovery “were starting to become more balanced.”
As for the future, the ECB said that “incoming information had to be monitored carefully, while more time was needed to better assess the recent uptick in inflation and the extent to which energy price developments were passing through to underlying inflation and affecting the medium-term outlook for price developments.”
Earlier in the day, the ECB announced that it had generated net profit of €1.19BN on its assets in 2016, vs €1.08B a year prior and €989BN in 2014, despite a massive surge in its balance sheet as interest rates declined and for many purchased bonds, turned negative.
For 2016, the net interest income on policy assets was €1.04B vs €0.89B in 2015, both accounting for the vast majority of the ECB’s “P&L.” The ECB also reported that interest income on foreign reserve assets rose to €370MM vs €283MM.
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