The ECB is likely to remain neutral
13 December 2021
By Althea Spinozzi, Senior Fixed Income Strategist, Saxo Bank
The ECB is likely to postpone any major monetary policy decision to the beginning of the next year. If Lagarde doesn't sound dovish enough, there is the risk that European sovereign yields will rise amid fears of fading ECB support.
The ECB continues to be divided between doves and hawks. The first see threats coming from a new Covid pandemic, and the others focus on inflationary pressures. Therefore it is safe to assume that the central bank will remain neutral and postpone any big decision to the beginning of next year. The problem with this notion is that the ECB has said several times that the PEPP program will end in March 2022, implying that the pace of bond buying will also be slowing in 2022. Therefore, the market expects that the end of the PEPP program will be compensated by another scheme such as the APP by making it more flexible. However, hawks reject this notion strongly, and it could prove challenging to find a compromise this week. Any deferral in the decision concerning a temporary replacement for the PEPP program could be perceived as fading ECB support, causing volatility in sovereigns with a high beta such as the periphery.
The ECB macroeconomic projections will also be in focus, particularly concerning inflation. In September, the central bank forecasted inflation at 2.25, 1,7%, and 1,5% for 2021, 2022, and 2023. It will be important to see if forecasts for 2022 and 2023 will be revised upwards, indicating that inflationary pressure might become more permanent.
From a bond point of view, it’s vital to recognize that covid distortions continue to cap bond yields. Still, more elements are putting upward pressure on them. Inflationary pressures, fading ECB support, and a new German government suggest that the only way for European yields is up. Therefore, if Lagarde sounds slightly less dovish than what the market expects, it might reason to see yields soaring.
Ten-year Bund yields have adjusted 15bps lower since the omicron variant was discovered. Contrary to our earlier analysis, we don’t believe that Bund yields will break above 0% by the end of the year due to the recent Covid restrictions. However, they could rise to test resistance at -0.20%.
Further reading : Fixed income market: the week ahead
