Recently, increasing bond yields and steepening yield curves have turned the attention to the policy decisions of major central banks. Market professionals who want to be sure of the link between economic recovery and bond market pricing are curious about the central banks' approach to this issue. In the action leg, there are certain policy options.
At the December 2020 meeting, the European Central Bank increased the total amount of bond purchases by extending the Pandemic Emergency Purchase Program (PEPP) and extended the cheap and long-term financing opportunities provided to banks through TLTROs. Inflation dynamics, which will be affected by commodity prices and possible increase in demand, have been added to the optimism achieved by vaccination and fiscal stimulus packages. This resulted in an increase in the bond yields with a maturity of more than 5 years, with the expectation that inflation would increase in the long run. The economic dynamics of Europe do not point to a recovery as shown by US data (strong employment increase in the last month, ISMs pointing to strong economic activity). However, the coordinated action of benchmark German rates with increasing correlation to US rates has brought bond market dynamics closer to each other.
You can see the periodic asset purchases of ECB in the chart. There have been statements from a few Governing Council members who expressed discomfort with the increased returns recently, but the ECB does not seem to put this into action at the moment. Because as they haven't bought any more bonds than ever before, there is a diminishing momentum. It means the disharmony of discourse and action. As high bond yields unnecessarily tighten financing conditions, policy options are in place for the ECB and action may be required.
The ECB remains the most likely option to increase net asset purchases under PEPP. While watching the weekly asset purchase amounts of the ECB, it will be possible to understand whether they are taking an action towards the yield curve from now on. On the other hand, we do not expect any change in the final aim of PEPP at this stage. In terms of economic projections, we assume that they do not see any risks threatening the medium-term outlook, but short-term inflation and growth projections may be affected. For the short term, an upward revision in inflation and a downward revision in growth can be expected.
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