Deflation fears drive down eurozone borrowing costs
Financial market bets that the European Central Bank will be forced to start buying government bonds to stem the threat of eurozone deflation are driving sovereign borrowing costs lower across the region, according to trading strategists.
Yields on eurozone government bonds, which move inversely with prices, have tumbled recently as investors have sought havens from tensions in Ukraine and other emerging market turmoil. Weak economic growth and inflation data – as well as the easing of the eurozone debt crisis – have also pushed yields lower.
But expectations are also building that the ECB – whose governing council meets on Thursday – could soon launch a large-scale asset purchase programme, or “quantitative easing”, to prevent the eurozone falling into a damaging deflationary slump. That could include buying government bonds.
While bond yields have fallen globally this year, “the recent moves in Europe have been more about discounting potential QE rather than global macro themes,” said Laurence Mutkin, head of global rates strategy at BNP Paribas. “They have been about something euro-centric, rather than a ‘risk-off’ trade or a recalibration of economic growth expectations.”
Mario Draghi, president of the ECB, has signalled this week’s meeting will be crucial to determine monetary policy strategy, with the central bank for the first time publishing an inflation forecast for 2016
While most ECB watchers still believe the central bank is some way from launching QE, “the market is getting ahead of the analysts,” said Huw Worthington, European interest rate strategist at Barclays. “There is the possibility of yields going back higher if the ECB does nothing.”
When the Bank of England and US Federal Reserve launched QE programmes, “a lot of the action came ahead of the announcement – people anticipated it – and a certain amount of that may be going on now,” added Mr Worthington.
Highlighting European markets’ increased sensitivity to news about inflation, eurozone yields on Friday reversed some of their recent falls after official data showed eurozone inflation was higher than expected in February. But at only 0.8 per cent, inflation was still far beneath the ECB’s target of an annual rate “below but close” to 2 per cent.
Whether markets are yet pricing in ECB asset purchases is unclear, however. “The market is at most pricing in a small possibility of QE happening,” said Anton Heese, co-head of European rates strategy at Morgan Stanley.
“The hurdles for the ECB to embark on full scale QE continue to look high to us, and QE is not priced in – if it was, yields would be lower still,” said Peter Goves, European rates strategist at Citigroup.
As well as government debt, the ECB could consider buying private-sector assets, including packages of bank loans to business.
Yields on 10-year German Bunds have recently fallen faster than on equivalent US Treasuries and last week they dipped to 1.55 per cent, the lowest since mid-2013
The differences, or “spreads,” between Spanish, Italian and Portuguese bonds and German equivalents have also narrowed. Spanish 10-year yields last week fell to the lowest since February 2006. Greek 10-year bond yields last week fell to less than 7 per cent for the first time since early 2010.