Articles
12 March 2021

Rates Spark: Fuzzy logic

The ECB announced a step-up in purchases. But its target remains as fuzzy as before and higher purchase volumes come with an expiry date. The disagreements within the governing council may raise the bar on future interventions. Near term, yesterday may prove bullish for bonds, but longer-term we see no need to adjust our bearish forecasts

Dovish ECB at first sight, ambiguous on the details

In the broad outlines, the ECB remains committed to its accommodative policy and reiterated that it will look through the temporary rise in inflation expected this year as economies reopen. The central bank’s macro assessment has not really changed as our economists write, but the subsequent press conference and media reports give the impression of a split Governing Council

Of course, bond markets were paying more attention to the ECB’s immediate response to the – in Christine Lagarde’s own words “undesirable” - increase in bond market yields. At first sight, elevating the announced increase in the pace of PEPP buying into the policy statement was a dovish surprise. What the ECB actually targets though when stating its aims to maintain favourable financing conditions remains as fuzzy of a concept as before.

A Reuters report later also confirmed that policymakers had different views of the desirable level of yields. The initial drop in Bund yields faded over the course of the press conference.

Italian bonds were the clear winner yesterday

But bond yields are only part of the ECB’s “holistic” and “multifaceted” approach to measuring financing conditions - to be precise, one of the upstream factors (readers may also want to refer to chief economist Philip Lane's speech on the topic for detail).

At least President Lagarde’s insistence that spreads were equally important made Italian bonds the clear winner yesterday with the 10-year spread over Bunds tightening by more than 6 basis points. If the ECB is explicitly not engaged in yield curve control, then maybe “spread control” comes closer to describing the strategy.

What can we look forward to in terms of buying volumes?

PEPP purchases will be conducted at a significantly higher pace compared to first months this year, no particular figure was given as to the exact volumes we can expect. It will be implemented immediately, but we won’t see the impact until the report on 22 March given that the data is reported on the basis of settled trades.

€60-100bn

of monthly ECB buying in the coming quarter

Reuters reported that policy makers set a monthly target with a small tolerance band around it – specifically that it would be higher than €60bn but less than the €100bn per month seen in spring 2020. There is also the issue that this is a wide range so the market could become concerned about under-delivery. Assuming that €60bn constitutes something akin to a baseline pace of buying the ECB currently has buffer of around €200bn taking into account what remains left of the PEPP envelope and that net buying is slated to end at the end of March 2022. In theory it would have comfortably allowed the ECB to raise monthly net buying volumes even somewhat above €100bn for the next three months without raising concerns about the overall size of the PEPP envelope.

Going forward the bar for PEPP buying to react to market circumstances is set higher than markets might initially have hoped for.

The question that remains is how much flexibility the ECB’s Executive Board actually has in day to day operations of the PEPP. What has become clear yesterday is that the pace of PEPP buying is a policy decision to be taken by the ECB’s Governing Council. PEPP is now set on autopilot at a higher pace for the next quarter, but it appears that going forward the bar for PEPP buying to react to market circumstances is set higher than markets might initially have hoped for. This is particularly true as divisions among the GC were laid bare by a Bloomberg story stressing that yesterday's decision was not intended as a signal that it will raise the PEPP envelope.

ECB frontloads PEPP

Source: ECB, ING - ECB purchases were announced to increase with immediate effect to a higher pace over the next quarter. In the chart the month of March includes 15 days at a pace implied by a monthly target of 100bn.
ECB, ING
ECB purchases were announced to increase with immediate effect to a higher pace over the next quarter. In the chart the month of March includes 15 days at a pace implied by a monthly target of 100bn.

Today’s events and market view

The ECB has announced a higher pace of PEPP buying and we would not stand against it for now. The increased buying has only just started and we would want to see how the market reacts. Lower yields are still possible as the ECB will want to make its impact felt. In the end though the ECB’s decision came with an expiry date (and apparently also an upper limit) and we think frontloading of buying only delays the eventual increase in interest rates.

Over the coming week US markets could also remain a dominating factor with Fed meeting looming large. This was underscored yesterday by the market reaction to a report by MNI that pondered the possibility of a change in the Fed’s dot plot.

Data today will be light. In the US we have the release of the University of Michigan consumer sentiment data and in the UK the monthly GDP for February.

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