How will the ECB respond to the rise in bond yields? - Capital Economics
European Economics

How will the ECB respond to the rise in bond yields?

European Economics Update
Written by Jack Allen-Reynolds

The recent increases in real bond yields leave them still at low levels, but ECB policymakers nonetheless seem uncomfortable. Their verbal interventions have had little impact so far, so we think that there is a good chance that they will increase their asset purchases to bring yields down again before long.

  • The recent increases in real bond yields leave them still at low levels, but ECB policymakers nonetheless seem uncomfortable. Their verbal interventions have had little impact so far, so we think that there is a good chance that they will increase their asset purchases to bring yields down again before long.
  • The sell-off in government bonds this year leaves BTP yields at their highest in several months, and Bund yields around their highest levels since last March. (See Chart 1.) Investment grade corporate bond yields have also increased, though there hasn’t been any movement in sub-investment grade yields. (See Chart 2.)
  • We have written extensively about the increase in yields on our Global Markets and Asset Allocation services. (See, for example, here and here.) For now, we would highlight three key points. The first is that yields are still low by historical standards. 10-year yields are still negative in Germany and only just above zero in France. In Italy they are below +0.8% despite the debt-to-GDP ratio approaching 160%.
  • The second is that, despite yields remaining very low, policymakers are uncomfortable. Unlike the Bank of Japan, the ECB doesn’t explicitly target a level of yields, so we don’t always know what level policymakers deem appropriate. This might explain why euro-zone yields have risen further than JGB yields recently. But a number of ECB policymakers have voiced their concern this week, with Isabel Schnabel warning of “a too abrupt increase in real interest rates on the back of improving global growth”.
  • Indeed, real Bund yields have risen by about 30bp this month (see Chart 3) alongside those in the US. This implies that investors have reassessed the outlook for monetary policy, rather than become more optimistic that strong growth will push up inflation. That’s also the message given by OIS rates. (See Chart 4.)
  • The third key point is that policymakers have the tools to bring yields down. Admittedly, the Bank could have sped up its asset purchases at any point over the past month and has chosen not to, as it keeps less tight control over bond markets than some other central banks. But policymakers’ recent remarks suggest that they are now getting twitchy. So we suspect that the ECB will increase its bond buying to bring yields back down. Moves in bond markets this morning suggest it could already be happening.
  • Chart 1: Nominal Government Bond Yields (%)

Chart 2: Nominal Euro Corporate Bond Yields (%)

Chart 3: Real 10yr Bund Yield & Breakeven Inflation (%)

Chart 4: ECB Deposit Rate & Overnight Rates (%)

Sources: Refinitiv, Capital Economics


Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com