Author: Alice Gledhill and Libby Cherry
Article: Original Article
Publication date: Sunday, December 18, 2022
The worst year for European bonds ended by one with the most massive sell-offs after the central banks warned investors that interest rates would exceed expectations.
The politician of the European central bank said that they are determined to suppress inflation. This is a shock for investors who put their money in the EU with a false sense of security considering the preliminary sense that inflation has already peaked.
Marker quickly responded to the ECB warning. Investors increased their expectations on peak rates to 3.3%. The yield of 10-year Italian bonds added more than 40 basis points, and this caused the worst sell-off since June. The yield of two-year German bonds reached 2.5%, the highest level since 2008.
The uncompromised tone of the ECB added credibility to Deutsche Bank AG and UBS Group AG recommendations under which the European yields should grow as high as their American counterparts. Just last week, the spread between the yield of German and American 10-year bonds has decreased at most since March 2020.
Despite the sharp price review, some doubt whether the ECB can deliver the promised level of tightening. It is related to the fact that the rapidly growing borrowing costs put the region at risk of an even deeper recession, increasing the damage already inflicted by the energy crisis.
Italy caught in the middle of the recent bond-market rout, causes particular concern. Its debt is the biggest in Europe. The difference between the yield of Italian and German bonds showed the highest weekly jump since April 2020.
“Too aggressive monetary policy may lead to even more sharp recession and increase of spreads on the bond market”, said Mohit Kumar, a rates strategist at Jefferies International. Maybe, ECB President Christine Lagarde has “gone a bit too far” expecting another increase in rates by 0.5% in February.
Also, the ECB presented the long-expected plan to reduce its huge balance by suspending the support for the market earlier than some supposed. According to Governing Council member Francois Villeroy de Galhau, the ECB will reduce the balance of bonds by 15 billion euros per month and potentially increase the pace from the end of the second quarter.
It will increase excessively the net bond supply as the government enhances its issuance to provide financing for programs protecting the citizens from inflation. BNP Paribas SA strategists expect the net supply of European government bonds to reach 228 billion euros ($242 billion) in the first quarter and 557 billion euros for the whole of 2023.
“Market couldn’t understand and price in that easing of fiscal policy amid high prices for energy products requires more tight monetary policy. Inflation reaches 10%. Deposit rates have room to grow”, says Axel Botte, a global strategist at Ostrum Asset Management. “It’s a wake-up call when the ECB hawks gain a lead.”
Forecast: growth of EURJPY
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