Christine Lagarde (R), President of the European Central Bank (ECB) and Vice-President Luis de Guindos (L)
Thomas Lohnes | Getty Images News | Getty Images
The central bank’s policy is largely based on signaling or verbal interventions.
The famous comment “whatever is needed” by former European Central Bank President Mario Draghi is the perfect example.
But only words fail to give an adequate result.
In recent weeks, ECB officials have spoken out loudly about raising yields on “unjustified tightening” or “a situation that we need to monitor closely”.
There is no unanimity in the Governing Council of the ECB on financing conditions that are likely to move south, with strong yields rising. 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 in US treasuries) have risen due to the belief that inflation will rise following the coronavirus pandemic and lead to a tightening of monetary conditions. Higher yields mean that borrowing governments face higher costs when servicing their debt, but it is also knocked down in the stock markets, with major companies also having to spend more on their obligations.
“We believe that recent market movements are putting this framework to its first significant test,” said Spyros Andreopoulos, senior European economist at BNP Paribas.
“Firstly, the ECB has to decide whether – and how – to intervene, given the significant increases in yields … Secondly, the ECB has to decide whether to make the notion of financing conditions more specific than so far.”
When the euro area central bank decided to add “maintaining favorable financing conditions” to its December targets, there was no clear understanding of what this actually means. There was a divergence in the interpretation of the term in the Governing Council, according to sources close to the decision-makers.
Recent inflation data in the region have been better than expected, with energy prices driving up. But also for the whole year, there is a clear reflectionist momentum due to the reopening of savings after the Covid-19 blockade.
“In recent speeches, ECB officials have not really addressed the latest rise in inflation rates and have been rather silent on the ECB’s inflation forecasts,” Carsten Brzeski, global head of macro affairs, told ING Research.
“In our view, overall inflation could exceed 2% in the second half of the year and we are very curious if the ECB shares this view.”
Meanwhile, data released on Monday showed that the ECB’s bond holdings in its pandemic stimulus program rose just 11.9 billion euros ($ 14.1 billion) in the week to March 3, down from € 12 billion a week earlier and below € 18.1 billion on average since the start of the program. This effectively means that bond buying is slowing down somewhat and putting increasing pressure on debt yields in the region. Yields are inversely related to the price of a bond.
Clearly, the sale of debt has not led the ECB to increase purchases and it is unclear whether the central bank has decided to ignore the increase in yields or whether it is waiting for the Governing Council to meet to find a common approach. We hope that the market will find the answer to Thursday’s meeting.