Bloomberg / Frankfurt
The European Central Bank will reveal tomorrow how serious it is about countering rising bond yields.
After days of top policy makers saying they won’t tolerate higher yields if they undermine the economy, the institution will publish its latest bond-buying figures. A significant increase in purchases would show they are backing their words with action.
Yet if the amount is little changed it could convince investors to push on with reflation trades, which are effectively bets the ECB will tolerate higher borrowing costs as the economy begins to recover.
Last week, those wagers sent yields across the region surging. Perhaps worryingly for President Christine Lagarde, they also widened the premium investors demand to hold the debt of the region’s riskiest nations, like Italy and Greece.
The trend is raising fears that the economic recovery being fostered by the torrent of cheap central bank money could be derailed for the region at large. “Actions speak louder than words,” said Mark Dowding, a money manager at Bluebay Asset Management, who bet on Friday morning that European debt prices will rebound.
“If the ECB is serious about wanting to stem a rise in yields, which could bring about a premature tightening in financial conditions, then it will need to act.”
The focus is on the ECB’s most-flexible bond plan, the €1.85tn ($2.2tn) pandemic emergency purchase program, the key crisis-fighting tool unveiled by the central bank in the early days of the pandemic.
In the week ended February 19, the central bank increased its holdings by €17.2bn, barely any higher than the previous week.
Over in the US, the economy is rapidly recovering as vaccines are rolled out quickly and where the government is preparing a massive fiscal stimulus package.
In contrast, the eurozone has been slow in inoculating the population and has had to extend business and social restrictions to contain the virus.
Its fiscal support is also smaller, and a breakthrough recovery fund won’t kick in until the middle of the year. The economy is set to contract this quarter, and the European Central Bank expects any inflation spikes this year to be only temporary, with job losses and uncertainty pushing down on prices.
Lagarde kicked off the past week by saying policymakers are “closely monitoring” nominal government bond yields because banks use them as benchmarks for the cost of loans to companies and households.
Chief Economist Philip Lane said on Thursday that the central bank will use the flexibility of its pandemic program to prevent any tightening of financial conditions that is “inconsistent” with its inflation goal. Those remarks only briefly stemmed the selloff.
Executive Board member Isabel Schnabel, who is responsible for market operations, said on Friday that a rise in real long-term rates may withdraw vital policy support too early, and that “policy will then have to step up its level of support.”
Economists at BofA Global Research said the central bankers appear to be getting nervous, and that persistently rising yields show the increase in buying so far clearly isn’t sufficient. “When the ECB is not making words and actions match, questions are asked,” they wrote in a report on Friday. “Letting market dynamics run further risks making a correction more costly.”
Next week: Aside from PEPP purchase figures on Monday, preliminary CPI data for February from across the region has the potential to add further impetus to the bond sell off if it comes in higher than expected on Tuesday.
Euro area CPI YoY estimate is 1%, with a prior reading of 0.9%; Some focus will also be on final PMI readings.
Scheduled central bank speakers include ECB’s Guindos, Makhlouf and Villeroy on Monday, while Knot and Centeno speak Thursday.
For the UK, the BoE’s Tenreyro speaks on Wednesday, followed by Haskel on Friday, while focus is also on the government’s budget and corresponding gilt outlook on Wednesday. The bond supply outlook could help support markets with net supply turning negative in the face of sales from France and Germany.
The EU will sell more SURE bonds via syndication.
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