The perception that central banks will look through any mid-year spike in inflation as economies open up once more has been proven with the European Central Bank (ECB) choosing to focus on the near-term issue of higher bond yields. The increase in the Pandemic Emergency Purchase Programme (PEPP) buying of bonds seems to be a direct response to the recent back up in yields, and a signal to the market to keep any further rises as orderly as possible.
Further evidence that the ECB disagrees with the recent pricing of inflation expectations (which caused the back up in yields) is that they haven’t changed their long-term inflation forecasts.
The ECB’s potential extra bond-buying intervention puts it at odds with other central banks such as the US Federal Reserve, which has chosen to rely on verbal intervention only. Given the relative growth expectations favouring the US at the moment, we think that makes sense – especially in light of the increased US fiscal stimulus and faster rollout of vaccines.
Implications for the euro are that it may be used as a cheap funding currency. Meanwhile, for bond markets, the game of buying Italian bonds versus German bonds, and credit versus cash, can continue for at least a couple of months more.
Paul Brain, head of fixed income, Newton Investment Management.