We now expect the ECB to cut the deposit rate by 10bp at the March meeting accompanied by a two-tier deposit rate system aimed at limiting the costs to the banking sector. We also expect the ECB to front-load QE purchases at EUR80bn per month in March to May but to maintain the total size of the programme.
The weaker growth and inflation outlook for the eurozone and further easing from the ECB mean that the earlier projected modest rise in 10Y government bond yields now looks distant and there is a possibility that Germany could be the next country after Switzerland and Japan to experience negative 10Y yields.
We still see upward pressure on 10Y yields on a 12-month horizon, as we still expect upward pressure on the long-end of US yields later in 2016. We still firmly believe that the ECB will be able to keep 2Y and 5Y yields in check with QE purchases and the deposit rate at -0.4%.
Also, in the US, there is little scope for higher yields over coming months. We believe the Fed will strike a more neutral bias at the next FOMC meeting but we still hold the view that the financial stress will eventually ease and the Fed will resume its hiking cycle, not least because the unemployment rate is at a very low level. A resumption of the hiking cycle should once again cause US yields to trend higher.
The Riksbank reacted to the low inflation at the policy meeting last week and slashed the deposit rate by 15bp to -0.50%. We do not see more rate cuts in Sweden but another expansion of the QE programme. In Norway, the low oil price is likely to trigger a final rate cut in March to 0.50% and finally Denmark is on the margin expected to follow the ECB lower, bringing the deposit rate back to -0.75%.
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