Yesterday’s selloff in European sovereign bonds indicates that without the European Central Bank’s continuous support, funding cost in the euro area is destined higher, which is something the central bank cannot allow.
The rise in yields in the United States is provoking a selloff of European sovereigns. In the month of February, European sovereign bonds fell by 1.2%, the most since March last year and January 2017 when Donald Trump took office. This is a big move that could soon tighten economic conditions in the Euro area.
The central bank’s main objective is to maintain price stability and reduce differences in financing conditions among businesses and households in the euro area. To achieve these goals, the ECB has deployed several measures, ranging from setting key interest rates to purchasing European assets outright.
Although most of the Euro area’s sovereign yields are still trading at historic low levels and many dived into negative territory at the end of last year, a fast widening of the spread versus the Bund in countries hardest hit by the pandemic might become a problem. Therefore, we expect the ECB to increase its bond purchases under the Pandemic Emergency Purchase Programme (PEPP), which remains widely unutilized. The ECB can purchase up to EUR 1.85 trillion under this program. Still, it has deployed so far only a little bit over EUR 800 billion, and purchases decreased the last quarter.
We believe that during next week’s ECB Press Conference, Christine Lagarde will highlight the importance of continuous support of the economy and an expansion of the monthly purchases under the PEPP program. It should be enough to see European sovereigns reverting their losses, especially in Spain, where the Bonos-Bund spread have widened faster than its peers.