ECB is accelerating bond purchases to support a sluggish economy

Transatlantic drift

The US economy is expected to far outperform the eurozone this year, but borrowing costs are rising on both sides of the Atlantic, a problem for the ECB.

Annual GDP, change from last year

The divergence in the short-term economic outlook between the US and the eurozone has made policy making more difficult for the ECB than for the Federal Reserve, which recently said it would not try to stop a rise in government bond yields. That view has rippled around the world, raising borrowing costs in both developed and developing countries.

At a press conference on Thursday, President Christine Lagarde said the ECB would try to counter a recent rise in bond yields, some of which she says reflects higher growth expectations in the US rather than a recovery in Europe. The very high indebtedness in some European countries – especially in the South, where debt exceeds 150% of gross domestic product – makes the euro area particularly vulnerable to rising financing costs.

To contain yields, the ECB will significantly accelerate purchases under a € 1.85 trillion bond purchase program, equivalent to $ 2.2 trillion, disclosed a year ago. This program aims to buy up government debt with the aim of keeping interest rates low. “We will be taking action tomorrow,” said Mrs Lagarde. The ECB also left its key interest rate unchanged at minus 0.5%.

The ECB’s move surprised investors and bounced back onto the financial markets, pushing European bond yields down. That takes the pressure off struggling European governments like Italy’s, whose benchmark 10-year bond yield fell from 0.681% to 0.577% on Wednesday, hitting its lowest level in three weeks. Revenues move inversely with prices.

According to the Organization for Economic Co-operation and Development, the eurozone economy is expected to grow by about 4% this year, compared to 6.5% in the US. That divergence reflects greater US fiscal stimulus and faster vaccine rollouts, the OECD said this week.

US bond yields are on the rise as investors expect the Fed to act sooner to raise interest rates to curb inflation, which is likely to rise as companies and employees spend more money. Bond yields in the eurozone are rising partly because investors in the US can receive higher premiums

ECB officials in recent days had expressed concern about rising eurozone bond yields, which would lead to higher financing costs for eurozone households and businesses. But the ECB had so far stopped speeding up its bond purchases, which it can do at any time.

“This is a bold and clever move that removes ambiguity, gives clear guidance to financial markets and gives the ECB a head start for some time,” said Marco Valli, an economist at UniCredit Bank in Milan.

Federal Reserve policymakers will meet on March 16-17 to consider their next move. Fed Chairman Jerome Powell gave no sign last week that the central bank would try to curb a recent rise in government bond yields, prompting them to rise further.

Ms. Lagarde would not say how much debt the ECB could buy in the coming weeks, or whether the central bank would expand its emergency bond buying program known as the Pandemic Emergency Purchase Program. Analysts suggested the ECB could accelerate its purchases to around € 90 billion per month, from € 60 billion currently.

The ECB has expanded the emergency program twice in recent months, most recently to € 1.85 trillion in December, and has about € 1 trillion in unused purchasing power. The central bank said on Thursday it would continue to buy bonds at least through March 2022 and was willing to adjust the size of the emergency program if necessary.

Ms Lagarde also did not shed light on a crucial question for investors: Does the ECB feel uncomfortable with financing costs at their current level, or is it worried they will get higher? That ambiguity could lead to more volatility in bond markets in the future, analysts said.

“As long as the markets behave, it could be enough,” said Frederik Ducrozet, a strategist at Pictet Wealth Management in Geneva. “But if bond yields start to rise again, the ECB may be forced to clarify this point.”

Write to Tom Fairless at [email protected]