ECB signals rising concern about eurozone bond market sell-off

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The European Central Bank has indicated it will increase the pace of its emergency bond purchases to counter the recent sell-off in eurozone sovereign debt markets if borrowing costs for governments, companies and households continue to rise.

Philip Lane, chief economist of the ECB, said on Thursday that the central bank was “closely monitoring the evolution of longer-term nominal bond yields” and its asset purchases “will be conducted to preserve favourable financing conditions over the pandemic period”.

The ECB has pledged to ensure financial conditions encourage investment and spending, helping the eurozone economy to make a swift recovery and lifting inflation towards the central bank objective of just below 2 per cent.

To achieve this, Lane signalled that it would rely on its pandemic emergency purchase programme, under which it plans to spend up to €1.85tn on buying bonds by March 2022. There is just under €1tn of that amount left to spend.

“We will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation,” he said.

Eurozone government bonds fell to their lowest levels for almost six months this week, and while Lane’s comments caused a brief rally on Thursday afternoon, prices then resumed their downward path.

Bond yields move inversely to prices, so the sell-off is pushing up the cost of borrowing for governments, which must sell vast amounts of extra debt this year to cover the cost of the coronavirus pandemic and its consequences.

Germany’s 10-year bond yield has risen to its highest level since last March, while the French equivalent returned to a positive yield for the first time since June and Italian sovereign yields hit their highest level since November.

ECB president Christine Lagarde said in a speech on Monday that policymakers were “closely monitoring” the rises. 

Isabel Schnabel, another ECB executive board member, said in an interview with Latvian news agency Leta published on Thursday: “A too-abrupt increase in real interest rates on the back of improving global growth prospects could jeopardise the economic recovery.”

Lane gave more detail of how the ECB defines “favourable” financing conditions, saying it would track the availability and cost of bank lending and market-based funding — in particular, the risk-free overnight index swap curve and the GDP-weighted eurozone sovereign bond yield curve, which have both risen in recent days.

He warned of the need to avoid “a mutually-reinforcing adverse loop” in which banks interpret lower borrowing demand as a negative signal about the economy and companies interpret a tightening of bank lending conditions as a worrying sign about the outlook. 

Eurozone bank lending to the private sector grew by just under €12bn in January, down 75 per cent from the average monthly loan growth last year according to data published on Thursday.

Much of the slowdown was because of a sharp fall in net lending to insurers and pension funds. Lending to non-financial companies also retreated slightly, while lending to households still grew but at its slowest rate since last April.

Krishna Guha, vice-president at Evercore ISI, said “ECB jawboning” was “having little effect” and “the next step — in our view presaged by Lane — is for the ECB to dial up the pace of its [bond] purchases”.

Last week the ECB spent a net €17.3bn on its emergency bond purchase programme, up slightly from the previous week but still well below the levels of last April, during the previous sell-off in government bond markets.

Frederik Ducrozet, strategist at Pictet Wealth Management, said the ECB was likely to wait until it was clear the bond market sell-off was a lasting shift before increasing its emergency bond buying above €20bn per week. But he said that “will bring the risk of disappointment [for investors] — because you have to walk the walk as well as talk the talk as a central bank”.

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