ECB set to end QE, boost the euro as political risks subside

London

BUY the euro, sell bonds.

That's the takeaway from strategists who expect that the European Central Bank (ECB) president Mario Draghi will announce on Thursday an end to the institution's asset-purchase programme as the immediate risks surrounding Italian politics subside.

Analysts have become more bullish on the euro following recent hawkish comments from ECB officials, with Credit Agricole SA forecasting that the shared currency will climb 7 per cent to US$1.26 by end-2018. Money market pricing indicates that interest rates will rise 15 basis points in September 2019.

Traders have been emboldened by policymakers including ECB chief economist Peter Praet, who signalled last week that the meeting could be pivotal in deciding an end-date to quantitative easing.

"That the ECB's chief economist is still talking about policy normalisation, even as the Italian political crisis rages, reinforces our belief that euro-dollar will get to 1.30 in the next six to 12 months," Societe Generale strategist Kit Juckes wrote in a note to clients. The pair currently hovers around US$1.1750.

JPMorgan Chase & Co recommends going short on longer-dated German bunds and Deutsche Bank AG prefers selling the front end of the yield curve. Meanwhile, a potential stumbling block to Morgan Stanley's steepening recommendation in bunds or euro interest-rate swaps is uncertainty over the outlook for Italy, according to the bank.

The ECB has also been taking a closer look at three of the eurozone's biggest trading books, according to people briefed on the matter.

The Frankfurt-based supervisor asked BNP Paribas SA, Deutsche Bank AG and Societe Generale SA several months ago to provide information about how they value bonds, stocks and derivatives on their trading books, the people said, asking not to be identified discussing confidential information. The review is now close to a conclusion, they said.

The ECB has made no secret of its intention to take a close look at the trading operations of the euro area's largest banks, particularly at how they use the leeway they are given to price hard-to-value assets and liabilities themselves.

Such Level 3 instruments represent less than 1 per cent of eurozone bank assets, ECB data shows, but they are considered important to keep an eye on because of the potential risks they pose to financial stability.

Daniele Nouy, chair of the ECB's supervisory board, said last month the institution had subjected major trading banks to "a combination of enhanced monitoring, 'deep dives' and on-site inspections" on Level 3 assets, though she wasn't specific about which firms were targeted. ECB executive board member Sabine Lautenschlaeger has also talked about collecting information on lenders. BLOOMBERG