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ECB to step up bond buying to counter government debt sell-off

ECB president Christine Lagarde. Photo: Michael Brochstein/Sipa USA
ECB president Christine Lagarde. Photo: Michael Brochstein/Sipa USA

The European Central Bank (ECB) moved to put a floor under eurozone government bonds on Thursday by announcing an acceleration of its programme of bond buying.

The ECB held eurozone interest rates unchanged and left its suite of monetary policy tools as-is, but said it would pick up the pace of its Pandemic Emergency Purchase Programme (PEPP).

The governing council said it would carry out PEPP purchases at a "significantly higher pace than during the first months of this year," signalling a willingness to step in and address a recent sell-off in government bonds. ECB president Christine Lagarde said the intervention was about maintaining cheap financing across the eurozone rather than managing debt costs for governments.

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Bonds around the world have sold-off in recent weeks as investors have begun to belief that stimulus will drive inflation as economies unlock. That, in turn, should force central banks to raise interest rates.

“Market interest rates have increased since the start of the year which poses a risk to wider financing conditions," ECB president Christine Lagarde said at a press conference.

Lagarde said rising bond yields "could translate into a premature tightening of financing conditions for all sections of the economy,” given that banks use market rates for benchmarking.

The ECB's governing council said it would step up PEPP purchases in response. The ECB will "purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions," the council said.

"After the recent increase in bond yields and heating up of inflation fears, market participants had started to speculate whether and how the ECB would react to these changes," said Carsten Brzeski, global head of macro at ING.

"The just-released statement suggests that the ECB is trying to demonstrate its willingness to put a cap on bond yields without showing signs of panic."

Italian stocks rallied on the news. Italian government bonds have been among the worst hit by the recent sell-off.

Lagarde, who famously said last year the ECB was not there to "close the spreads" between eurozone government debt yields, said her central bank was not targeting specific yield levels.

“We are not doing yield curve control — we are preserving favourable financing conditions with a look at the inflation outlook that we have and how one contributes to reducing the downward impact of the pandemic on our inflation path," she said.

Lagarde said the ECB had revised up its forecast for eurozone inflation from 1% to 1.5% this year but said this was largely due to "temporary" factors and rising energy costs. Medium-term inflation forecasts were broadly unchanged and Lagarde said “underlying” pressure on inflation was still “subdued” due to “weak demand and significant slack in labour and product markets.”

New economic forecasts were published alongside the monetary policy statement, showing a "broadly unchanged" outlook Lagarde said.

The eurozone economy looks likely to contract in the first quarter of 2021 before a “firm rebound" later in the year supported by vaccination campaigns, she said.

The ECB's governing council maintained the eurozone's headline interest rate at 0% and kept the deposit rate for banks at -0.5%. The central bank's suite of unconventional monetary tools were maintained at existing levels.

Economists and analysts had widely forecast no changes ahead of the meeting, following an extensive recalibration of monetary policy in December.

"The governing council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry," the ECB said.

The euro had been rising against the dollar (EURUSD=X) and pound (GBPEUR=X) ahead of Thursday's statement but sold off slightly after the announcement. The euro was up 0.2% against the dollar shortly after the announcement.

The euro sold off slightly against the dollar after the ECB's policy announcement. Photo: Yahoo Finance UK
The euro sold off slightly against the dollar after the ECB's policy announcement. Photo: Yahoo Finance UK

"The ECB left the powder dry in their meeting today," said Naeem Aslam, chief market analyst at Avatrade. "However, the overall narrative is taken dovish by market players and this has pushed the euro lower against the dollar."

Lagarde repeated her call for European politicians to adopt an “ambitious and coordinated fiscal stance." She said fiscal support was "critical."

Earlier this week the OECD upgraded its forecasts for eurozone growth this year but urged the bloc to speed up the pace of its COVID-19 vaccination campaign.

“Countries like Germany and France, mainly in Europe, are vaccinating far more slowly," Laurence Boone, the OECD's chief economist, said at a press conference on Tuesday. “That makes it harder to recover.

“Not vaccinating quickly enough also risks undermining the fiscal stimulus that has been put in place.”

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