EU markets surge as investors believe Lagarde will embrace dovish policy

Government borrowing costs across the single-currency bloc tumbled to record lows and euro zone blue-chip stocks hit their highest in more than a year after Lagarde was appointed

European markets surged on Wednesday as investors bet that France's Christine Lagarde would double-down on the European Central Bank's dovish monetary easing stance as the bank's next chief.

Government borrowing costs across the single-currency bloc tumbled to record lows and euro zone blue-chip stocks hit their highest in more than a year after EU leaders agreed late on Tuesday to name Lagarde as the ECB's new head.

A shrewd negotiator who has run the IMF but has little monetary policy experience, Lagarde would face the challenge as the ECB's new chief of having to revive the euro zone economy with a nearly depleted policy arsenal.

For now, investors focused on two positive factors. One, that a monetary policy hawk such as Germany's Jens Weidmann would not be taking over from Italy's Mario Draghi at the ECB from November. Two, the likelihood that Lagarde was unlikely to alter the ECB's current dovish policy stance, judging by recent comments.

"Crucially, Lagarde has always been supportive of the ECB's unconventional policies, including QE (quantitative easing), which is essential for the credibility of future decisions," said Pictet Wealth Management strategist Frederik Ducrozet. "She could very well be the one implementing a QE2 programme in her first year as president."

Like other major central banks, the ECB has done an about-turn on its policy stance this year, saying it stands ready to ease policy again if inflation remains weak.

Euro zone money markets anticipate a 10 basis point cut in the ECB's deposit rate in September and expectations for another round of asset purchases are building.

Most 10-year euro zone bond yields slid to fresh record lows on Wednesday as investors bet the ECB's dovish stance would continue under Lagarde.

Belgium's 10-year bond yield turned negative for the first time. Benchmark German Bund yields fell to minus 0.399 per cent — flirting with the ECB's minus 0.40 deposit rate in a further sign that markets are braced for further rate cuts. The euro held steady at $1.1284 and euro zone stocks rose to their highest in over a year.

Andrew Kenningham, chief Europe economist at Capital Economics, which expects the ECB to cut rates in September and relaunch asset purchases before year-end, said the risk to that forecast was the possibility of a hawk succeeding Draghi.

"So it follows that the key thing about the appointment of Christine Lagarde as the next head of the ECB is that she is not Jens Weidmann," he said.

In Italy, viewed as a key beneficiary of new ECB QE, 10-year bond yields slid 22 bps to 1.63 per cent, its lowest level since October 2016. Two-year yields have turned negative for the first time in over a year. The closely watched Italy/Germany 10-year bond yield spread was closing in on 200 basis points for the first time in over a year.

In another positive development for Italy, the EC dropped its threat of disciplinary action against Italy.