Market

European bonds slip on prospect of inflation hitting 2% by 2025

Sovereign bonds updates

The prospect of the European Central Bank lifting interest rates earlier than many analysts had expected hit eurozone bonds on Friday, pushing German borrowing costs to the highest in more than two months.

The moves came after the Financial Times reported that the ECB expects to hit its 2 per cent inflation target by 2025, according to unpublished internal models that imply a rate rise from record lows could happen as soon as late 2023. That would be well before many economists expect.

The ECB said in a statement after the FT story was published that the idea of it raising rates in 2023 was “not consistent with our forward guidance”.

The central bank also denied the FT’s report that ECB chief economist Philip Lane had said during a private call with German economists on Wednesday that “the euro area will reach 2 per cent inflation soon after the end of the ECB’s projection horizon”. Two people involved in the call told the FT that was what they understood him to have said.

Germany’s bonds fell in price on Friday, pushing the country’s 10-year bond yield — a reference for debt markets across the currency bloc — up by 0.03 percentage points to minus 0.27 per cent, the highest since early July. Italian 10-year yields, a key barometer of sentiment towards riskier debt, climbed 0.05 percentage points to 0.74 per cent. The euro briefly nudged higher against the dollar before falling back.

The prospect of a 2023 rate rise does not come as a surprise to all market participants. Futures markets linked to short term interest rates were already pricing a rise to minus 0.4 per cent by autumn of that year. Even so, some investors are sensitive to any suggestion that anxiety over inflation could lead to an earlier tightening of monetary policy.

“It’s perhaps not surprising that the ECB has models that predict it will eventually hit its inflation target, even if that’s some way off,” said Antoine Bouvet, a senior rates strategist at ING. “But this comes at a time when current inflation numbers are rising and there’s more talk about inflation in general. It definitely struck a chord with some investors and that’s what’s driven the market move.”

Officials at the central bank downplayed the importance of the ECB’s “medium-term reference scenario” that Lane referred to during the private call. This model looks five years further into the future than the ECB’s published forecasts and is not usually made public.

Spanish central bank governor Pablo Hernandez de Cos, who sits on the ECB governing council, said on Friday that the idea of a rate rise in late 2023 was “clearly ahead of what the market is expecting today”. He pointed to inflation swap markets that have risen recently but are still not pricing in inflation of 2 per cent in the coming years.

But other national central bank heads on the ECB council said publicly that the ECB could raise its inflation forecast further. “Some of us do believe that actually the forecasts are too pessimistic,” Ireland’s Gabriel Makhlouf said at an online event: “Some of us do believe that at the moment the forecast of reaching inflation of 1.5 per cent in 2023 is too low.”

Latvia’s Martins Kazaks said in a Bloomberg interview published on Friday: “If Covid does not surprise on the negative side, there is some upside for the inflation outlook over the medium term.” 

Eurozone inflation shot up to a decade-high of 3 per cent in August, but official ECB forecasts indicate it will fade next year and reach 1.5 per cent in 2023. It is due to publish 2024 forecasts in December, which will be closely watched by investors to see how close it is to its target.

“We think it is unlikely, but not impossible, that the ECB might reach its inflation target durably by 2025, and it would be good news, not bad news — including for risk assets — if it did,” said Krishna Guha, vice-chair of Evercore ISI. 

“The key here is the degree of protection against a hawkish policy error based on over-optimistic forecasts provided by the new ECB forward guidance,” said Guha, adding that a rate rise was unlikely in 2023.

Most Related Links :
honestcolumnist Governmental News Finance News

Source link

Back to top button