EURO ZONE YIELDS EDGE HIGHER AFTER ECB LEFT POLICY UNCHANGED

The ECB left policy unchanged as expected on Thursday, keeping copious stimulus flowing even as it faces questions over how it might claw back support once the pandemic-stricken euro zone economy reopens. The ECB is keeping borrowing costs pinned near record lows.

Euro zone government bond yields edged higher after a policy statement from the European Central Bank, with investors looking for clues during the ECB news conference on how it would react to an expected economic recovery. The ECB will likely be pressed on signs of divisions over the future pace of bond purchases, which have been stepped up recently to prevent a rise in borrowing costs from derailing the recovery.

Germany’s 10-year government bond yield, the benchmark for the euro area, rose 0.5 basis points to -0.25%. Italy’s 10-year yield rose 1.5 basis points to 0.78%, with the risk premium on top of German bonds widening to around 102 basis points.UK 10 year yield rose 0.74% and Greece 10 year yield at 0.915%, whereas France 10 year yield remain subdued.

Some analysts have recently flagged concerns about a possible “hawkish mistake” by the ECB in June following good news about the European economy. The ECB is unlikely to dismiss the possibility of taper in June, likely leaving our bearish tactical bias intact. The decision on what to do with the PEPP after March 2022 is likely to be taken in September.

Despite concerns about the ECB’s possible exit from the purchase programme, “prospects for the periphery are improving near-term. The rejection of the preliminary injunction against NGEU (EU pandemic recovery fund) by the German Constitutional Court was a surprise. Germany’s constitutional court declined on Wednesday to block the recovery fund, but it did not indicate when it would rule on the full complaint against the fund. France and Spain will be in the primary market with auctions, with analysts expecting supply to be absorbed well.

Once the recovery takes hold and the ECB cuts bond purchases, the key question will be just how much of a rise in euro zone government bond yields is warranted and how the central bank can avoid the impression of micro-managing yields.