ECB’s dovish surprise to suppress bond yields - Capital Economics
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ECB’s dovish surprise to suppress bond yields

European Economics Update
Written by Andrew Kenningham
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The ECB’s statement that it expects the pace of its PEPP purchases to be “significantly higher” in the coming quarter suggests that it will, at a minimum, resist further upward pressure on bond yields and is consistent with our forecast that sovereign bond yields will come down a bit this year.

  • The ECB’s statement that it expects the pace of its PEPP purchases to be “significantly higher” in the coming quarter suggests that it will, at a minimum, resist further upward pressure on bond yields and is consistent with our forecast that sovereign bond yields will come down a bit this year.
  • After seeming to adopt a policy of benign neglect for the past two weeks, the ECB today announced that it will step up its bond purchases after all. The key sentence in its policy statement is that it “expects [PEPP purchases] over the next quarter to be conducted at a significantly higher pace than during the first months of this year”. These purchases will be made “flexibly according to market conditions and with a view to preventing a tightening of financing conditions.” While it has taken a while, this is the policy response we had anticipated. (See here and our last ECB WatchHesitant ECB to step up bond purchases”.)
  • In the press conference, ECB President Christine Lagarde explained that the reason they had not acted earlier was simply that they wanted to wait for the Governing Council meeting, which was “only a few days away”. (Peripheral yields began rising on 12th February and jumped sharply on 25th February, two weeks ago.) That leaves us unsure how quickly the Bank will respond to any future market pressures.
  • It is also unclear what the ECB considers a “significant” increase in purchases. Average weekly purchases this year have been just over €12bn, compared to €15bn in the H2 last year and a lot more during March-June 2020. (See Chart 1.) Our best guess is that net weekly purchases will be closer to €20bn over the next three months, but we cannot be sure. The Bank may put more emphasis on preventing yields from returning to the levels they peaked at in late February, i.e. targeting price rather than quantity.
  • The announcement has already had a notable impact on bond yields. (See Chart 2.) The ten-year Italian sovereign bond yield has fallen from 0.66% before the meeting to 0.60% at the time of writing. The euro has been more volatile but is now little changed from before the meeting. We suspect that peripheral yields will continue to trend down in the coming weeks.
  • Meanwhile, the ECB’s new economic forecasts were exactly as we had anticipated. The Bank expects inflation of 1.5% this year, from 1.0% previously, but did not change its 1.4% forecast for 2023. President Lagarde rehearsed arguments which we expect to hear a lot in the coming months: higher inflation reflects “technical” factors and will be short-lived, so the Bank will “look through” it. We agree with this but expect headline inflation to go above 2% this year and to be around 3½% in Germany. That may cause tensions on the Governing Council, but these should subside if we are right to expect inflation to fall back next year.
  • Still, the big picture is that the ECB will persist with negative rates and large weekly asset purchases for a long time to come. This will keep bond yields low and wider financing conditions very accommodative by historical standards, and compared to the US. For now, the Bank has corrected the impression of being a little careless about the bond market. But its ambiguous policy framework, slow policymaking and clunky communications threaten to leave investors at sea (despite Ms Lagarde’s love of compasses and anchors!) This combination may also lead to more bond market volatility in future.

Chart 1: Net PEPP Purchases (€bn)

Chart 2: US$ Per Euro and Italian Bond Yield (%)

Sources: Refinitiv, CE

Sources: ECB, CE


Andrew Kenningham, Chief Europe Economist, andrew.kenningham@capitaleconomics.com