Surging yields are creating problems for the ECB

Christine Lagarde (R), President of the European Central Bank (ECB), and Vicepresident Luis de Guindos (L)

Thomas Lohnes | Getty Images News | Getty Images

Central bank policy in large part is based on signaling, or verbal interventions.  

The famous “whatever it takes” comment from former European Central Bank President Mario Draghi is the perfect example.  

But words alone can also fail to provide a suitable outcome. 

In recent weeks, ECB officials have been vocal in calling the rise in bond yields “unwarranted tightening” or “a situation which we have to monitor closely.” 

There is no unanimity in the ECB’s Governing Council as to whether financing conditions are at risk of turning south with the strong rise in yields. And market participants would like to better understand the ECB’s possible responses to this, with the central bank due to meet this week. 

In recent weeks, yields on fixed income assets (especially on U.S. Treasurys) have risen due to a belief that inflation will pick up following the coronavirus pandemic and lead to a tightening of monetary conditions. Higher yields mean governments who borrow face higher costs when servicing their debts, but it’s also knocked stock markets with major firms also having to spend more on their debt obligations.  

“We think that recent market moves are putting that framework to its first significant test,” Spyros Andreopoulos, a senior European economist at BNP Paribas, said. 

“First the ECB must decide whether — and how to — intervene given meaningful increases in yields … Second, the ECB must decide whether to make the notion of financing conditions more specific than it has so far.” 

When the euro zone’s central bank decided to add “maintaining favorable financing conditions” to its targets back in December, there was no clear understanding of what that actually meant. Inside the Governing Council there was a divergence on the interpretation of the term, according to sources close to the decision makers. 

Recent inflation data in the region has been better than expected with energy prices driving the increases. But also for the full year, there is a clear reflationary push due to the reopening of the economies after Covid-19 lockdowns. 

“In recent speeches, ECB officials did not really address the latest increase in inflation rates and were rather silent on the ECB’s inflation forecasts,” said Carsten Brzeski, the global head of macro, at ING Research.   

“In our view, headline inflation could top 2% in the second half of the year and we are very curious whether the ECB shares this view.” 

In the meantime, data published on Monday showed that the ECB’s bond holdings in its pandemic stimulus program increased only by 11.9 billion euros ($14.1 billion) in the week to March 3, down from 12 billion euro a week earlier and below the 18.1 billion euro average since the program started. This effectively means its bond buying is slowing somewhat, and putting further upward pressure on debt yields in the region. Yields have an inverse relationship with a bond’s price. 

The debt sell-off obviously did not prompt the ECB to scale up purchases, and it’s not clear whether the central bank decided to ignore the rise in yields or whether it was waiting for the Governing Council to convene to find a common approach. Hopefully the market will find the answer at Thursday’s meeting.

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