ECB probably more important than Draghi for BTPs - Capital Economics
Capital Daily

ECB probably more important than Draghi for BTPs

Capital Daily
Written by Franziska Palmas

A successful outcome to Mario Draghi’s attempt to form a new government in Italy would probably be good news for the country’s sovereign bonds (BTPs). But even if the current political crisis drags on for a while, we expect the ten-year BTP yield to fall back this year.

  • We think both the Bank of England and the Czech National Bank will leave policy unchanged
  • Euro-zone retail sales probably rose in December (10.00 GMT)
  • You can check our highest conviction macro calls and their market implications here

Key Market Themes

A successful outcome to Mario Draghi’s attempt to form a new government in Italy would probably be good news for the country’s sovereign bonds (BTPs). But even if the current political crisis drags on for a while, we expect the ten-year BTP yield to fall back this year.

Investors have welcomed the news that former ECB President Mario Draghi has been tasked to form a new government in Italy after an attempt by outgoing prime minister Giuseppe Conte to find a new majority failed. The yield of ten-year BTPs is down by around 10bp on the day, and the FTSE MIB index is up about 2.0%, which compares to a gain of just ~0.3% for the Euro Stoxx 600.

The enthusiasm is presumably partly due to the fact that Draghi has established a lot of credibility in financial markets from his tenure as ECB president. It probably also reflects the fact that a Draghi government would remove the risk of new elections leading to the rise to power of the eurosceptic Lega party. Indeed, political developments in Italy have tended to cause sharp rises in the ten-year BTP yield only when a shift to a government likely to clash with the EU appeared in the cards. This was the case after Matteo Renzi’s resignation in 2016 and after the formation of the Lega-Five Star Movement coalition in 2018. (See Chart 1.)

Chart 1: 10-Year BTP Yield (%)

Sources: Refinitiv, Capital Economics

That said, Draghi’s success is far from guaranteed. The two largest parties in parliament, the Five Star Movement and the Lega, have both expressed reservations about a Draghi government. If Draghi fails, investors might worry that elections are inevitable, putting renewed upward pressure on BTP yields. Nonetheless, we would still expect the ten-year yield to fall back by end-2021. This is mainly because we think that the ECB will not allow Italian yields to rise significantly and that it may even want to drive them lower to ease monetary conditions.

Admittedly, Christine Lagarde’s slightly hawkish tone at the press conference following the ECB’s latest meeting raised concerns that the central bank may be willing to tolerate somewhat higher “peripheral” sovereign bond yields. And the higher-than-expected January inflation figures may make any debate in the Governing Council about further easing more contentious.

However, since the press conference various members of the ECB’s executive board have appeared to suggest that the central bank would not be happy with higher peripheral yields. Philip Lane stressed in a recent speech that any premature steepening of yield curves would not be consistent with the ECB’s aim to counter the negative shock of the pandemic on inflation. And Isabel Schnabel emphasised that it is crucial for the ECB to maintain a strong presence in the bond market to prevent fragmentation and ensure that the ECB can achieve its monetary policy goals.

Meanwhile, we suspect that the ECB will look through the rise in inflation given that it is driven mainly by temporary factors. And the deterioration in the economic outlook due to recent extension of lockdowns and the significant delays in the vaccine roll-out in the EU only strengthen the case for the ECB to keep monetary conditions loose.

What’s more, we think that the global backdrop will be conducive to a further rally in BTPs, as growing appetite for risk encourages a general hunt for yield. Taking all these things together, we forecast the ten-year BTP yield to fall from ~0.6% currently to 0.2% by the end of 2021. (Franziska Palmas)

Selected Data & Events




CE Forecast*

Thu 4th


BoE Monetary Policy Decision





*m/m(y/y) unless otherwise stated; p = provisional

Key Data & Events


The further rise in the ISM services index to a two-year high of 58.7 in January, from 57.7, suggests the wider economy remains resilient to the recent wave of virus cases. With several states now starting to ease restrictions on activity and recent fiscal support set to feed through, this supports our view that GDP growth will start to rebound in the first quarter. The rise in the headline survey was driven partly by a jump in the employment index. Alongside the 174,000 rebound in private employment reported by ADP earlier on Wednesday, that suggests the risks to our forecast that non-farm payrolls were unchanged last month now lie to the upside. (Andrew Hunter)


The jump in euro-zone inflation from -0.3% in December to +0.9% in January reflects several one-off factors, some of which will be reversed in February. Even so, headline inflation is likely to rise to around 2% by the end of the year, before dropping back next year. Meanwhile, the euro-zone Composite PMI fell in January. Italy’s PMI rose while Spain’s fell, but both remained below the 50-mark. These data support our view that the euro-zone economy has started the new year on the back foot. With the vaccine rollout stalling already and new virus strains circulating, the risks to our forecasts that the recovery will start near the end of Q2 are firmly to the downside.

As for the forthcoming data, we think that euro-zone retail sales increased in December. But given the sharp fall in sales in Germany that month, the increase will not have been enough to offset November’s drop and sales are likely to have remained below their pre-pandemic level.

In the UK, we expect the Bank of England to leave its policy settings unchanged at its meeting on Thursday. The Bank is due to announce the findings from its consultation about what steps financial services institutions need to take to deal with negative interest rates. While the Bank will probably confirm that it is moving closer to being able to use negative interest rates, we don’t think that it will implement them either this year or next. (Melanie Debono & Thomas Pugh)

Other Developed Markets

In New Zealand, the fall in the unemployment rate to 4.9% suggests that unemployment is already past its peak. We expect the labour market to continue to tighten in 2021. (Ben Udy)


The Caixin services PMI dropped from 56.3 to a nine-month low of 52.0 in January, mirroring falls in the official PMIs and Caixin manufacturing index. The surveys point to a levelling off of in China’s economic rebound, with services activity hit by renewed virus flare-ups across several provinces last month. But with the virus situation now coming back under control, we think that growth in services will pick up again before long. (Sheana Yue)

Other Emerging Markets

In Emerging Europe, headline inflation in Turkey rose to 15.0% y/y in January, which was in line with our forecast. While inflation may edge up a little further in the next few months, we think that policymakers will keep interest rates on hold for the rest of this year. Meanwhile, Poland‘s central bank left its policy rate at 0.10% on Wednesday. While the arguments in favour of further easing have faded recently, we still think it is more likely than not that the Bank will follow up its FX intervention to weaken the zloty with a 10bp rate cut in March. Finally, we suspect that Czechia’s central bank will leave its repo rate at 0.25% on Thursday. Admittedly, GDP in Q4 was much stronger than the central bank expected and, together with stubbornly above-target inflation, this could prompt a hawkish shift. But given the pace of the economic recovery hinges on the rollout of vaccines and inflationary pressures are likely to fade this year, we still think it is unlikely that any rate hikes will come before 2022.

In the Middle East and North Africa, January’s batch of whole economy PMIs for the region showed that economic recoveries have struggled to gain more momentum as fresh virus outbreaks have prompted a tightening of conditions. Meanwhile, we expect the Central Bank of Egypt (CBE) to leave its overnight deposit rate at 8.25% at Thursday’s MPC meeting. Despite inflation having eased from 5.7% y/y in November to 5.4% y/y in December, the headline rate remains above the lower bound of the CBE’s inflation target of 7±2%. And with inflation likely to rise over the next 6-9 months, we think policymakers will keep rates on hold until later in the year. (Bethany Beckett, James Swanston and Liam Peach)

Published at 16.10 GMT 3rd February 2021.

Editor: John Higgins

Enquiries: Bradley Saunders