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Borrowing costs for eurozone governments are rising again, testing the nerves of European Central Bank policymakers ahead of their decision on whether to delay asset purchases from next month.
If the ECB marks its bond purchase from its recent pace of just over € 80 billion in net purchases per month at the next governing council meeting on June 10, it will join other central banks that already they have done so in response to better economic prospects, including in Canada and the United Kingdom.
U.S. Federal Reserve officials have done so discussed if you start talking about reducing bond purchases at a meeting in late April.
But the recent rise in bond yields underscores the caution the ECB will need to take when withdrawing from its emergency stimulus efforts if it wants to avoid an unwanted rise in financing costs for some of the weaker economies. of the block.
In response to a question on Friday about whether the ECB would slow bond purchases, its chairman Christine Lagarde said it was “too early and in fact there is no need to debate long-term issues”.
“I have repeatedly said that policymakers must provide the right bridge to cross the pandemic, until recovery, so that we can fulfill our mandate, and that is what we will do,” Lagarde added.
Withdrawing monetary stimulus after a crisis is a balance. Doing it too fast can scare investors, putting recovery at risk. But do it too slowly and the economy may overheat, which will make it more painful to tighten politics later.
“It’s a magician’s trick,” said Paul Diggle, chief economist at Aberdeen Standard Investments. “If Lagarde can manage communications to be very reassuring, he may be able to prevent this from being called reduced and deepening sales.”
The more conservative “hawks” of the ECB council have been pushing for weeks slow down of bond purchases, arguing that this is justified by an improved growth and inflation outlook that is likely to be reflected in the central bank’s latest forecasts next month.
However, there are some more “dovish” board members pushed back, calling on the ECB to maintain the stimulus at least until the economy has fully recovered from the pandemic and inflation has risen sustainably in line with its target.
A board member said the ECB is unlikely to slow bond purchases because investors are overreacting to fears of rising inflation, which the central bank believes will only be temporary, adding: “We do not want encourage it by sending a slow-moving signal “.
The ECB’s decision is compounded by the recent fall in government bond prices, which has raised the weighted average GDP of ten-year yields in the euro area to 0.27%, the highest since June past.
The movement has been driven in part by an increase in German debt costs – a benchmark for the rest of the euro area, from very low levels since the beginning of the year, as investors respond to an improving outlook.
Germany’s ten-year yield was relatively high minus 0.12% on Friday. Goldman Sachs analysts predict that performance will position itself later this year.
The challenge for the ECB will be that it has pledged to maintain “favorable financing conditions”, preventing the borrowing costs of households, businesses and governments from outpacing the economic recovery.
The ECB reacted to the last significant jump in eurozone bond yields earlier this year by committing to buying bonds at a “significantly higher pace” during the second quarter.
But at the time, the eurozone was still weighed down by coronavirus containment measures, and the central bank viewed rising bond yields as an unwarranted overflow from the U.S., which was recovering more quickly due to a $ 1.9 million fiscal stimulus package.
Now, investors think the European bond market is driven by more genuine signs of recovery. “There was quite a bit of pessimism in the eurozone outlook earlier this year,” said Mohammed Kazmi, portfolio manager at Union Bancaire Privée. “Now, with the acceleration of vaccination programs, we see a pace of recovery with part of the optimism that is already priced in the United States.”
Brighter growth prospects diminish the attractiveness of ultra-secure assets such as German government bonds. Inflation expectations have also risen, both at home and abroad.
The ten-year German inequality rate, a market-based measure of inflation expectations, stands at 1.41%, compared to less than 1% earlier this year. While this is still well below the ECB’s target of below 2%, it means that real yields – adjusted for inflation – have remained flat despite the sale of the bond market.
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Katharina Utermöhl, an economist at Allianz, said higher inflation expectations make it more likely that the ECB will “get a little off the ground” by slowing bond purchases between the pace of the first and second quarters , adding that this would still be “a communication challenge”.
The risk is that the ECB could accelerate a recent rise in borrowing costs for weaker and more indebted economies, the so-called periphery of the eurozone. Italy’s ten-year yield on Wednesday reached a eight-month high of 1.16%. The additional, or differential, yield that Rome pays compared to Berlin for ten-year debt peaked since January.
“It’s easy for hawks to say that all of this is part of a healthy recovery from inflation expectations and that the absolute level of returns is still low,” said Frederik Ducrozet, strategist at Pictet Wealth Management. “But when you talk about the risk to recovery, you have to look at peripheral differentials.”
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