In a recent article titled, Will bond markets turn too fast and too furious for the ECB?, AB argued the ECB’s tolerance for yet higher yields is likely to be limited.
The German 10-year yield rose by 100 basis points from a low of 0.05 per cent in April to over one per cent.
“Perhaps surprisingly, the ECB has not been unduly ruffled by these developments,” said report author and AB senior European economist Darren Williams.
Mr Williams pointed out that higher bond yields reflect improved economic growth and inflation forecasts within the eurozone.
According to Mr Williams, the increase in bond yields is a sign that the ECB’s quantitative easing (QE) program is working.
“Unlike in other countries, QE in the euro area is not primarily about reducing long-term bond yields (which were already at record lows long before the launch of the program),” he said.
“Rather, it’s about underpinning inflation expectations and underscoring the ECB’s commitment to do ‘whatever it takes’ to prevent the euro area slipping into deflation.”
While the effects of QE are a reasonable explanation as to why bond yields have increased, caution is necessary, Mr Williams said.
In recent weeks, inflation expectations did not keep pace with the rise of bond yields. This led to “de facto tightening” of financial conditions, he said.
The premature tightening of financial conditions needs to be monitored, Mr Williams said.
This is significant, as “one of the key factors underpinning our positive view on the euro area outlook is the improvement in monetary conditions that has taken place over the last year”.
“Despite its calm reaction to recent market developments, the ECB is likely to have similar concerns.
“[The ECB’s] tolerance for yet higher bond yields is therefore likely to be limited, in our view,” Mr Williams concluded.
