ECB Confronts Rising Yields, Delayed Recovery: Decision Guide

(Bloomberg) -- European Central Bank officials are about to decide whether rising bond yields are such a threat to the region’s virus-stricken economy that they need to come up with a stronger response.

The policy announcement at 1:45 p.m. Frankfurt time on Thursday, and President Christine Lagarde’s press conference, should reveal which of two arguments has prevailed. Either higher borrowing costs are an unwarranted tightening of financial conditions, or they simply reflect optimism about the ultimate recovery from the pandemic.

The jump in global yields has triggered reactions among policy makers ranging from reassurance to apparent alarm. The euro-zone economy may not be ready to cope with higher borrowing costs -- it’s lagging far behind the U.S., where a faster vaccine rollout and $1.9 trillion fiscal stimulus package are turbocharging its rebound.

“To avoid an unwarranted tightening of financing conditions -- in plain words: a market upset -- the ECB needs to provide clearer guidance,” said Florian Hense, an economist at Berenberg.

Policy Decision

While most economists surveyed by Bloomberg say the central bank will eventually extend its 1.85 trillion-euro ($2.2 trillion) pandemic bond-buying program beyond the current end-date of March 2022, that decision looks unlikely at this meeting. No change is expected to the deposit rate of -0.5% either, or anything beyond technical tweaks to the long-term loan program.

Instead, the focus will be on the language. Investors are looking for any hint that the ECB plans to deploy the much-touted flexibility of its bond program to contain yields.

Purchases have barely picked up over the past two weeks, tempting investors to test how much of a market shift officials are willing to tolerate.

Lagarde Statement

If the policy statement doesn’t deliver, the president’s press conference 45 minutes later might do so. Should Lagarde describe higher yields as an “unwarranted tightening” of financial conditions, it’ll be a signal that policy makers will act to rein them in.

The term was used by her predecessor, Mario Draghi, in 2014 as he laid the ground for negative interest rates and quantitative easing.

Since December, the ECB has pledged to keep financial conditions “favorable” using the flexibility of its emergency program. Gilles Moec, chief economist at Axa SA, expects Lagarde to use her introductory statement to give more prominence to that pledge -- potentially with an explicit reference to current market conditions.

What Bloomberg Economics Says...

“The ECB has emphasized its intention to maintain favorable financing conditions in an effort to support the recovery. We anticipate a clear message from the Governing Council that higher bond yields are triggering an unwarranted tightening of conditions.”

-Maeva Cousin, David Powell and Jamie Rush. Read the ECB PREVIEW

ECB watchers are hoping for more though -- they want to know what indicators the central bank is monitoring. At its last policy meeting, the Governing Council told staff to report back in March with proposals.

So far, public comments by policy makers have confused as much as clarified, with references to nominal yields -- Executive Board member Fabio Panetta said increases are “unwelcome and must be resisted” -- but also inflation-adjusted ones. Vice President Luis de Guindos focused on yield differentials between nations to say the situation is “calm.”

Chief Economist Philip Lane has referred to a “holistic” approach, using a speech last month to look at bank-based and market-based conditions.

Economic Projections

The ECB will also reveal updated economic projections, the first since December and a crucial justification for the assessment of whether bond yields are unwarranted or not.

They’re likely to be cautious, judging that any jump in the inflation rate will be temporary, according to officials with knowledge of the matter.

The outlook assumes that hoarded savings won’t be depleted in a sudden consumption boom when lockdown restrictions ease, the officials said. An ECB spokesman declined to comment.

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