Rising bond yields, resilient manufacturing - Capital Economics
European Economics

Rising bond yields, resilient manufacturing

European Economics Weekly
Written by Andrew Kenningham

We doubt that the increase in sovereign bond yields this week is the beginning of sustained rise in borrowing costs, even if the headline inflation rate rises further. Meanwhile, we are looking forward to the breakdown of January’s HICP inflation data next week for more evidence of how much of the increase was due to temporary factors.

We will also be hosting a twenty-minute “drop-in” conversation about the inflation outlook following the final HICP inflation data release on Tuesday. The session is at 15.00 GMT and you can register here.

 

Borrowing costs on the rise

Sovereign bond yields throughout the euro-zone rose sharply this week, raising questions about the outlook for growth and inflation. Ten-year German and Italian bond yields, for example, rose by 15bp and 20bp respectively.

However, we are not too worried about these moves. For a start, the increase in bond yields so far has been small by global standards. Ten-year Italian yields fell below their US equivalent in early October and have edged down since then, whereas US yields have risen steadily. (See Chart 1.)

Chart 1: 10-year Government Bond Yields (%)

Source: Refinitiv

Of course, yields could rise a lot further if there is a sustained rise in inflation. Headline inflation has already jumped to +0.9% in January and a number of factors is likely to push it up further in the coming months, including higher energy price inflation and possibly the effect of pent-up demand meeting limited supply in the hospitality sector as businesses re-open The flash PMIs for February provided more evidence that input shortages and higher transport costs are putting upward pressure on prices of manufactured goods, although output prices are rising less than input prices. (See here.)

That said, we expect underlying price pressures to remain weak in the coming year or two. The scale of fiscal support in Europe is trivial compared to that in the US: job support programmes are being extended but these only partly compensate for a loss of private income. (See here.) And business investment is likely to remain subdued. While we think inflation will exceed 2% in the second half of this year, it is likely to drop back again in 2022, allowing the ECB to keep its foot on the accelerator.

Indeed, policymakers will want to ensure that bond yields remain capped at low levels even if headline inflation rises. As we noted here, the account of the January meeting shows that the ECB was not worried about rising risk-free yields so long as credit spreads and real yields remained low. Some on the Governing Council thought the ECB should allow rising inflation expectations to drive real yields down, rather than allow nominal yields to rise. We have pencilled in the first ECB deposit rate hike for 2026, three years later than anticipated by markets.

Contraction in Q1 GDP is likely

Other than consumer confidence for February (see here), the main data release this week was the flash PMIs. These offered more evidence of the divergence between the booming manufacturing sector and struggling services. At this stage we have no hard data on which to assess the outlook for Q1 GDP. (January’s retail sales figures will not be available for two more weeks, whereas the UK and US data have already been published.) For what it’s worth, high frequency data show that mobility has stabilised at a lower level than in Q4. So on balance, it still looks most likely that euro-zone GDP will decline slightly in Q1, in line with our -0.5% q/q forecast. But another decline in GDP is not yet a done deal.

The week ahead

We will be hosting a twenty-minute drop-in conversation about the inflation outlook following the final HICP inflation data release for January, on Tuesday. (You can register here for the session, which begins at 15:00 GMT.) The only other data of interest are the EC Economic Sentiment Indicator and Germany Ifo Business Climate Index, which may shed more light on the state of activity in February.


Data Previews

Euro-zone Economic Sentiment Indicator (Feb.) Mon. 22nd Feb./Thurs. 25th Feb.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

22nd February

       

German Ifo BCI

09.00

90.1

90.1

91.0

25th February

       

Euro-zone ESI

10.00

91.5

92.0

92.0

Still subdued

The European Commission’s Economic Sentiment Indicator (ESI) may have risen a touch in February, but the big picture is that it remains low compared to pre-pandemic levels.

The ESI fell slightly in January as lockdown measures caused declines in the retail, services and consumer confidence components. Sentiment fell in Germany and France, but rose in Italy and Spain.

We already know that the EC’s measure of euro-zone consumer confidence, which accounts for 20% of the ESI, edged up in February.

Business sentiment is harder to gauge, given governments’ tinkering with restrictions this year. But the survey evidence suggests on balance that it might have improved a bit too. The euro-zone and German ZEW investor sentiment indices both rose. So too did the Composite PMI. Admittedly, unlike the ESI and the German Ifo, the PMIs do not include retail which will have been hit by February’s restrictions. But the PMIs also put a greater weight on services than either the ESI or the Ifo.

On balance, therefore, we think both the German Ifo and the EC’s ESI for the euro-zone nudged up in February. But the latter would still be consistent with euro-zone GDP continuing to fall in year-on-year terms. (See Chart 2.)

Chart 2: Euro-zone ESI & GDP

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 22nd

Ger

Ifo Survey (Feb)

10.00

(09.00)

90.1

90.1

91.0

Tue 23rd

EZ

CPI (Jan, Final)

11.00

(10.00)

+0.2%(+0.9%)p

+0.2%(+0.9%)

 
 

EZ

Core CPI (Jan., Final)

11.00

(10.00)

-0.5%(+1.4%)p

-0.5%(+1.4%)

 

CE

Webinar: Euro-zone Inflation & ECB

16.00

(15.00)

Wed 24th

Ger

GDP (Q4, Final, q/q(y/y)

08.00

(07.00)

+0.1%(-2.9%)p

+0.1%(-2.9%)

+0.1%(-2.9%)

 

Ger

Gov’t Deficit (2020, Maastricht, % of GDP)

08.00

(07.00)

(+1.5%)

(-4.8%)

 

Fra

INSEE Business Confidence (Feb)

08.45

(07.45)

92.0

Thu 25th

Ger

GfK Consumer Confidence (Mar)

08.00

(07.00)

-15.6

 

Fra

Consumer Confidence (Feb)

08.45

(07.45)

92

 

EZ

M3 Money Supply (Jan)

10.00

(09.00)

+1.4%(+12.3%)

 

EZ

EC Business & Consumer Survey

11.00

(10.00)

91.5

92.0

92.0

 

EZ

ECB’s Lane speaks at CMVM Webinar

11.45

(10.45)

Fri 26th

Fin

GDP (Q4, q/q(y/y))

07.00

(08.00)

+3.3%(-2.7%)

 

Fra

CPI (Feb, EU Harm, Prov.)

08.45

(07.45)

 

Fra

GDP (Q4, Final, q/q(y/y))

08.45

(07.45)

-1.3%(-5.0%)p

-1.3%(-5.0%)

-1.3%(-5.0%)

 

Fra

Household Spending, Goods (Jan,))

08.45

(07.45)

+23.0%(+3.7%)

 

Spa

CPI (Feb, EU Harm, Prov.)

09.00

(08.00)

-0.4%(+0.4%)

 

EZ

ECB’s Schnabel speaks at EFB Annual Conf.

09.30

(08.30)

 

EZ

ECB’s Lagarde at G20 Finance Mins Meeting

12.00

(11.00)

Selected future data releases and events

Mon 1st

EZ

Manufacturing PMI (Feb, Final)

10.00

(09.00)

57.7p

57.7

 

Ita

CPI (Feb, EU Harm., Prov.)

11.00

(10.00)

-1.1%(+0.2%)

 

Ger

CPI (Feb, EU Harm., Prov.)

14.00

(13.00)

+1.4%(+1.6%)

Tue 2nd

EZ

Flash CPI (Feb)

11.00

(10.00)

Wed 3rd

Ita

GDP (Q4, Final, q/q(y/y))

10.00

(09.00)

-2.0%(-6.6%)p

-2.0%(-6.6%)

-2.0%(-6.6%)

 

EZ

Composite PMI (Feb, Final)

10.00

(09.00)

48.1p

48.1

Thu 4th

EZ

Unemployment Rate (Jan)

11.00

(10.00)

8.3%

 

EZ

Retail Sales (Jan)

11.00

(10.00)

+2.0%(+0.6%)

Fri 5th

Ger

Factory Orders (Jan)

09.55

(08.55)

-1.9%(+6.4%)

*m/m(y/y) unless otherwise stated. p=provisional. Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2019

2020

2021

2022

GDP

-0.6(-5.0)

-0.6(-5.0)

-0.5(-1.8)

+1.4(+12.8)

+2.2(+2.4)

+1.1(+4.2)

+1.3

-6.8

+4.0

+4.0

Household Spending

+14.0(-4.6)

-2.5(-7.0)

-0.7(-3.4)

+2.5(+13.1)

+2.4(+1.6)

+1.8(+6.1)

+1.3

-7.9

+4.1

+4.8

HICP (%y/y)

+0.9 (Jan)

-0.3

0.9

1.6

1.8

2.2

+1.2

+0.3

+1.6

+0.7

Unemployment Rate (%)

8.3 (Dec)

8.4

8.6

8.8

8.6

8.4

7.6

8.0

8.5

8.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

10yr Bund Yield, end period (%)

-0.33

-0.58

-0.35

-0.40

-0.45

-0.50

-0.19

-0.58

-0.50

-0.25

$/euro, end period

1.21

1.22

1.22

1.23

1.24

1.25

1.12

1.22

1.25

1.25

£/euro, end period

0.87

0.89

0.87

0.87

0.87

0.86

0.85

0.88

0.86

0.86

Sources: Bloomberg, Capital Economics


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