Draghi Faces Calmest Europe Stock Market Since QE Kicked Off

A rare moment of calm in Europe’s stock market greets Mario Draghi as the European Central Bank meets this week on interest rates.

Volatility hasn’t been this low in the days preceding an ECB meeting since the start of quantitative easing in 2015, lending cover for the central-bank president should he choose to leave policy mostly alone, as economists forecast. The VStoxx Index trades 23 percent below its average before the ECB’s last 10 decisions, a level of tranquility that has little precedent since interest rates were cut and bond purchases begun last year.

It’s a stark contrast to previous meetings, when Draghi faced upheaval and pressure to allay concerns ranging from a slowdown in China to Britain’s shock vote to secede. Equities have recovered from their post-Brexit slump and investors are taking their cue from American markets, where the CBOE Volatility Index just posted one of its calmest months since the financial crisis.

While traders are divided on whether the Federal Reserve will tighten in September, bets on a rate cut in Europe have tumbled since July.

“It’s a little surreal that volatility is this low,” said Peter Garnry, head of equity strategy at Saxo Bank A/S in Hellerup, Denmark. “It’s all very wait-and-see. The ECB won’t do anything before the Fed acts. Draghi is satisfied with that, and for once markets are satisfied too. It may be quiet now but it’s not a stupid move to buy some cheap protection here.”

The VStoxx Index, which tracks volatility expectations for the Euro Stoxx 50 Index, declined 52 percent since a June peak through Tuesday as central banks in Europe and the U.K. assured investors they’d be ready to react to any fallout from Brexit. The gauge in August posted its first back-to-back monthly drop since early 2015, when Draghi soothed equity markets by announcing an asset-purchase plan. It lost 2.7 percent on Wednesday.

Also taking the pressure off the ECB for further rate cuts are better-than-expected economic data in the past two months. While traders were pricing in more than even odds of a deposit-rate cut on Thursday as recently as July, the probability is now about 11 percent. The Euro Stoxx 50 has rallied 14 percent since a low in June, rising to a three-month high last week.

The ECB will probably extend its 1.7 trillion euro ($1.9 trillion) asset-purchase program beyond its current end-date of March 2017, according to most economists in a Bloomberg survey. The central bank on Thursday also publishes updates to its forecasts for gross domestic product and inflation, helping guide investors on what to expect for the rest of the year.

For some, the concern is that the economic momentum is too fragile to handle political risks. While euro-area equities have recovered declines stemming from the Brexit vote, strategists at Barclays Plc highlighted Italy’s referendum on constitutional changes, expected in November, as a potential threat to growth prospects. A Citigroup Inc. index of economic surprises for the region has turned negative for the first time since July, meaning reports that miss projections outnumber those that surpass them.

“In view of the systemic importance of the Italian banking sector for Europe, we subscribe to the view that a confirmation of the referendum date could lead to an expansion of the risk premium, in line with the experience ahead of the U.K. referendum,” Barclays equity derivative strategists led by Christian Kober wrote in a Sept. 5 note.

Daniel Murray at EFG Asset Management remains optimistic, predicting that volatility will stay muted after Thursday’s meeting. The VStoxx Index is down 14 percent for 2016, and near its lowest level in more than a year.

“The outlook for the ECB on Thursday is relatively benign,” said Murray, head of research at EFG in London. “I don’t think this meeting will contain many surprises. The macro data in Europe has been remarkably well-behaved. While there were some concerns at the beginning of the year that the situation will deteriorate significantly, the year has proven to be relatively stable.”

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