Soaring Yields Oust the Euro as the ECB’s Biggest Problem
(Bloomberg Opinion) -- Christine Lagarde has some explaining to do at Thursday’s European Central Bank meeting.
Amid the fixed-income rout and soaring yields, the ECB has been far too cautious in using its most visible weapon: Quantitative Easing bond buying. The bank has bought only 12 billion euros ($14 billion), net of redemptions, over each of the last two weeks — short of the 18 billion euros it had been buying on average each week since the pandemic program started a year ago.
The ECB president needs to make a statement of intent that it will cap bond yields, and it can do so without specifying yield level, maturity or even which country’s debt. That is the beauty of the wide-ranging flexibility embedded in the pandemic program.
Most of the ECB’s executive board has been vocal in calling for more purchases. Board member Fabio Panetta said last Tuesday that the jump in government-bond yields “is unwelcome and must be resisted.” But all this talk hasn’t produced enough action. If anything, the jawboning risks rendering ECB policy ineffective if yields get too high.
The bank’s one stroke of luck is that it’s managed to avert a currency crisis: The euro has been weak against both a resurgent dollar and also sterling. For such an export-led economy, having too strong a currency would impede recovery just when it is needed most. Several ECB members must be relieved about this after breaking with the usual tradition of not mentioning currency movements when the euro rose sharply at the end of last year.
With a vast $1.9 trillion stimulus package about to be approved by the U.S. Congress, which has even led to the OECD upgrading growth forecasts for the U.K. and European Union, a reflation scare could push euro area yields up higher. The bloc needs to be proactive in making sure its financing conditions stay attractive to engender its own domestic-led recovery — and this means keeping bond yields low.
Thursday’s quarterly review of economic forecasts is the perfect time to clarify the bank’s evolving strategy. This vision below, which was heralded at the last governing council press conference in late January, just won’t do.
“So how do we identify whether or not we are in the presence of favourable financing conditions? Well, I would say first of all it is based on a holistic and multifaceted approach, our assessment, and it is intended for all sectors. So, all sectors means households, SMEs, corporates, sovereigns. And we look at the financing conditions and as a result of that we look at the bank lending rates. We look at the credit conditions, we look at the yields of corporates, yields of sovereigns…”
ECB chief economist Philip Lane laid out the academic argument for this strategy of identifying favorable financial conditions on Feb. 25, but while it may have been clear to central bankers, the opaque measures don’t give traders a good sense of how many bonds will be bought and when. That’s not reassuring when yields are spiking. Similarly, citing large redemptions as to why the QE buying has dipped is not going to cut it for much longer.
If Lagarde doesn’t coherently explain further what “new favorable financial conditions” means in terms of substantive policy instruments, then she risks a repeat of the “we're not here to close spreads” incident that roiled markets less than a year ago.
It’s time for the ECB to put its massive QE program to use. Without more bond buying, fear will creep back into the markets and yields could spike further. When the pandemic emergency purchase program was expanded at the December meeting, there was a restrictive rider added calling its 1.85 trillion euros a ceiling not a target. Either way, the bank is far from reaching it and shouldn’t be holding back now.
With the slow rollout of vaccines across the EU and the potential for additional lockdowns, the last thing the ECB wants is a taper tantrum.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
©2021 Bloomberg L.P.