ECB pledges to step up pace of stimulus to counter market sell-off

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The European Central Bank has said it will accelerate the pace of its bond buying over the next three months in response to the eurozone’s rising borrowing costs and faltering economic recovery from the coronavirus pandemic.

In its latest monetary policy decision, published on Thursday, the central bank kept its policies unchanged, but said: “Based on a joint assessment of financing conditions and the inflation outlook, the governing council expects purchases under the [pandemic emergency purchase programme] over the next quarter to be conducted at a significantly higher pace than during the first months of this year.”

The statement came against a backdrop of growing interest among investors and economists about how it will respond to the recent sell-off in bond markets, which risks hampering the single currency bloc’s already-stuttering recovery by pushing up the cost of finance for businesses and households.

The ECB bought fewer bonds through its main pandemic-related stimulus programme in recent weeks despite the rise in borrowing costs, but faces growing pressure to increase the pace of its asset purchases.

The ECB added that it would “purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation”.

European government debt rallied following the announcement. The yield on Italian 10-year bonds dropped by 0.09 percentage points to 0.58 per cent, hitting its lowest level this month. Yields fall as prices rise.

The spread between the Italian and German 10-year yields — a key measure of political risk in the eurozone — tightened to 0.95 percentage points, down from 0.97 earlier in the day. The yield on the regional benchmark 10-year German Bund dropped 0.04 percentage points to its lowest level in a week at minus 0.35 per cent.

Analysts expect ECB president Christine Lagarde to elaborate on the decision at a press conference later on Thursday.

Some ECB officials worry the bond market sell-off, which has been fuelled by investors’ expectations that a rapid US economic recovery will reignite inflation, will prove a headwind to eurozone nations’ economic recovery while they are still weighed down by restrictions to contain the spread of Covid-19. 

However, other policymakers are more sanguine, arguing that higher bond yields reflect an improving economic outlook and that overall financing conditions are still highly favourable. Bond yields rise as their prices fall. 

Lena Komileva, chief economist at G+ Economics, said the ECB was locked in a “new culture war” between those wanting it to maintain lower debt costs to support the recovery and hit its inflation target and those who fear it could threaten its independence by propping up over-indebted governments.

“If unresolved, this clash will undermine market confidence and ultimately lead to new financial stress as we enter the vaccine-managed endgame [of the] pandemic,” said Komileva. “The markets need a clear message about what the ECB’s targets and priorities are and what it is prepared to do to achieve them.”

The ECB left its deposit rate at minus 0.5 per cent and reiterated that its €1.85tn emergency bond-buying programme could be further expanded or not used in full, depending on its progress in stimulating a recovery in output and inflation.

The central bank is due to publish new forecasts later on Thursday that are likely to increase its projections for inflation while lowering this year’s growth outlook. But it is expected to predict that inflation will still remain well below its target of just under 2 per cent in 2023, justifying continued monetary stimulus.

Economists fear that persistently high rates of coronavirus infections and the sluggish pace of the EU’s vaccination programme will delay the recovery in the eurozone economy, which is heading for a second consecutive quarter of declining output in the first three months of this year. 

The OECD this week urged the EU to accelerate its vaccination efforts and predicted the eurozone’s recovery would lag behind most of its major trading partners, with gross domestic product forecast to grow by less than 4 per cent this year.

Additional reporting by Joshua Oliver in London

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