Eurozone bond yields drop after ECB’s Schnabel says further rate hikes unlikely
EUROZONE bond yields fell to new multi-month lows on Tuesday (Dec 5) after European Central Bank (ECB) official Isabel Schnabel said further interest hikes are “rather unlikely” in an interview with Reuters, given a marked slowdown in inflation in November.
Germany’s 10-year bond yield fell by seven basis points to 2.279 per cent, its lowest since June, with several market analysts attributing the drop to Schnabel’s comments.
Schnabel said she shifted her stance after three unexpectedly benign inflation readings in a row. November’s figure showed that price rises slowed to 2.4 per cent year on year, near the ECB’s 2 per cent target and down sharply from more than 10 per cent a year earlier.
“The most recent inflation number has made a further rate increase rather unlikely,” she said.
Just a month ago, after October data also showed slowing price growth, Schnabel had cautioned that it was too early to rule out another rate hike. She had also compared the fight to bring inflation to the ECB’s 2 per cent target with overcoming the last mile in a long-distance run.
Her tone has shifted, becoming more confident that the backdrop is shifting.
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“The November flash release was a very pleasant surprise,” she said. “Most importantly, underlying inflation, which has proven more stubborn, is now also falling more quickly than we had expected. This is quite remarkable. All in all, inflation developments have been encouraging.”
Investors are now fully pricing in an interest rate cut in April; Schnabel did not rule out such a move could transpire.
“We have to see what’s going to happen,” she said. “We have been surprised many times in both directions. So, we should be careful in making statements about something that is going to happen in six months’ time.”
Germany’s two-year bond yield, which is sensitive to ECB rate expectations, fell by eight basis points to 2.602 per cent, its lowest since mid-May.
Schnabel’s comments were having a “massive impact”, said Jussi Hiljanen, head of European rates strategy at lender SEB, who said the German official was one of the most influential policymakers on the ECB’s Governing Council.
“The hawks are clearly turning more dovish,” he said. “I would say it’s almost impossible now to push back against the rate cut expectations.”
On Tuesday, traders in eurozone money markets reckoned there was a roughly 84 per cent chance of a 25 basis point cut coming in March, up from around 72 per cent the previous day. They now envisage more than 140 basis points of cuts by the end of December.
Italy’s 10-year bond yield was last down six basis points to 4.053 per cent, its lowest since late July.
The gap between Italian and German 10-year yields fell slightly to 175 basis points.
Schnabel is not yet fully confident that prices have been tamed. Mirroring comments on Monday by ECB vice-president Luis de Guindos, she cautioned that “we must not declare victory over inflation prematurely”.
“We continue to expect an uptick over the coming months,” she said. “There’s going to be a reversal of some fiscal measures and of some base effects, and we cannot exclude that there’s going to be a new price spike in energy or food.”
Bundesbank president Joachim Nagel has struck a similar tone, warning that geopolitical tensions could also stoke price pressures.
Policymakers are expected to keep rates on hold for a second time when they meet on Dec 13 to 14. They will also present new economic forecasts that will stretch out to 2026 for the first time.
UBS economists led by Reinhard Cluse said in a note on Monday that the ECB will probably have to lower its outlook for growth and inflation in 2023 and 2024.
The ECB is currently set to reinvest maturing bonds from the so-called pandemic emergency purchase programme (PEPP) of 1.7 trillion euros (S$2.46 trillion) until the end of 2024. Several officials have pushed to revisit that stance, however, as the economy overcomes lingering pandemic effects and bond reduction proceeds only slowly.
A key feature of the PEPP reinvestments is that they can be deployed flexibly across jurisdictions, acting as the first line of defence against gyrations on euro-area bond markets.
“As (ECB president Christine) Lagarde mentioned, the Governing Council is going to discuss reinvestments under the PEPP in the not-too-distant future, and I’ll leave it up to you to interpret what that means,” Schnabel said.
She insisted that any decision wouldn’t be a “big deal.”
“It’s clear that discussion is going to come,” Schnabel said. “It’s also clear that at some point we’re going to fully end PEPP reinvestments. The amounts involved are relatively small and markets are expecting this to happen.”
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