Rising long-term yields and uncertainty concerning the conflict in Israel will force the ECB to remain on hold at this week’s monetary policy meeting.
Since the beginning of September, 10-year US Treasury yields rose by roughly 90bps from 4.10% to 5% today, forcing European sovereign yields also higher. German 10-year yields aim to reach 3% for the first time since 2011, and Italian sovereign yields are at their highest since 2012 in the wake of the European sovereign crisis. Higher long-term rates are tightening the economy further, leaving little reason for another interest rate hike.
At the same time, the ECB has a limited amount of new information to tweak its monetary policy further. The Bank Lending Survey, third-quarter GDP data, and a new round of staff projections will be available only by the December monetary policy meeting. Therefore, the focus at this meeting shifts toward policymakers' conversation about non-interest rate monetary policy tools such as minimum reserve requirement and an early end of reinvestment of the Pandemic Emergency Purchase Program (PEPP).
Yet, it is unlikely that the PEPP program will be disinvested anytime soon. As yields continue to rise, the BTP-Bund spread rose to 200bps, threatening to increase further amid volatility. As the central bank remains concerned about funding squeezes in the periphery, particularly in Italy, it will take a lot to alter the PEPP program.
The focus is on US Treasuries and the Japanese investors.
This week, European sovereigns will be sensitive to the direction of US Treasuries and decisions concerning the BOJ's Yield Curve Control. The rise in yields seems unstoppable for the following reasons:
1. Inflation expectations are rising again; hence, central banks might need to hold rates higher for longer. Geopolitical tensions in the Middle East put upward pressure on inflationary pressures. The 10-year breakeven rate rose to 2.47% recently from 2.10% in March. The 5-year 5-year Forward rate and 10-year CPI swap are rising again towards 3%, indicating that high inflation might persist.