ECB Weighs Pace of Stimulus as Bond Rout Spurs Calls to Act

(Bloomberg) -- European Central Bank officials are taking a leaf from former President Mario Draghi’s playbook as they ask if recent market moves amount to “unwarranted tightening” that requires action.

That test, deployed by Christine Lagarde’s predecessor in 2014 in the run-up to negative interest rates and quantitative easing, is relevant now as the euro-zone economy lags behind the global recovery from the pandemic. Yet the ECB starts its two-day policy meeting on Wednesday apparently divided on whether recent gains in government bond yields should be a source of concern.

Officials including Executive Board member Fabio Panetta argue that higher yields are “unwelcome and must be resisted.” Others such as Dutch Governor Klaas Knot point to economic optimism about the second half of the year as a possible justification for such market moves.

Lagarde has stopped short of commenting beyond her emphasis on preserving favorable financing conditions for households and businesses. Her officials haven’t disclosed which indicators they’re monitoring, and have even given conflicting signals of the measures that matter.

What Bloomberg Economics Says...

“Our analysis gives reason for calm -- borrowing costs would need to jump by four times as much to push debt servicing burdens back to the levels seen in the aftermath of the euro-zone crisis.”

--Maeva Cousin. To read her report, click here.

Here’s a closer look at their arguments before the Governing Council’s policy decision on Thursday.

Coterie of Concern

The case for alarm would be that the rise in yields isn’t a reflection of any fundamental shift in the euro-area economy, but driven by developments in other parts of the world outside the ECB’s control.

French Governor Francois Villeroy de Galhau signaled the need for a response when he argued that the ECB “can and must react” to any unwarranted moves. He and some colleagues have pinned the surge in yields to “excessive spillovers” from the U.S., where lawmakers are working on a $1.9 trillion stimulus package to support the economy.

Spain’s Pablo Hernandez de Cos has underscored that the rise in nominal interest rates hasn’t triggered corresponding increases in inflation expectations, and warned that “this may have a negative impact on economic activity and thus inflation.”

While such policy makers might seek an acceleration in the pace of purchases, there’s little pressure so far to expand the size of the ECB’s 1.85 trillion-euro ($2.2 trillion) pandemic purchase plan. More than half of that amount is yet unspent.

Unflustered Faction

The case for the rise in yields being warranted is that health authorities are making progress in vaccinations, laying the foundations for a strong economic bounceback. In such a situation, it would be unrealistic for officials to hope financial conditions should remain as low now as they were in December.

Anatoli Annenkov, an economist at Societe Generale in London, wonders if some of the concern about rising yields is overblown.

“Markets may be a little bit ahead of themselves but we haven’t seen anything in real interest rates that would hurt the recovery,” he said.

Inflation expectations are near the highest levels in almost two years, and economists surveyed by Bloomberg predict consumer prices will rise faster than previously predicted. Business confidence among purchasing managers is at a three-year high, with German factories recording order gains nearly three times faster than expected.

Knot insisted last week that higher yields are a “positive story” because they reflect expectations for improvement. ECB Vice President Luis de Guindos observed that the increase was from very low levels and “in terms of spreads, the situation is very calm.”

Bundesbank President Jens Weidmann is also unbothered, arguing in a Bloomberg Television interview that “the size of the movements is not such that this is a particularly worrisome development.”

Common Ground

Lagarde herself hasn’t uttered the words “unwarranted tightening,” a conscious omission which leaves investors guessing where her opinion lies. Instead, her focus has been on borrowing costs for the real economy, which have stayed stable.

“The ECB will help ensure that firms and families can access the finance they need to weather this storm -- and that they can do so in the confidence that financing conditions will not tighten prematurely,” Lagarde said last week.

An important guide for her and the rest of the Governing Council will be new projections for growth and inflation which will be released on Thursday. They’re likely to show near-term prospects worsening after a slow start to vaccinations. But policy makers also insist there’s also no reason to question a strong recovery in the second half.

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