What Next for the European Bond Market?

The ECB may soon run out of government bonds to buy for a number of countries, particularly Germany - which will impact fixed income returns

Jose Garcia Zarate 25 August, 2017 | 8:03AM
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Jose Garcia Zarate: The prospect of parity between sterling and the euro is getting closer. This is partly though not entirely related to the downside risks to the UK economy due to Brexit. The eurozone economy is doing pretty well. In fact, as we head into the latter part of the year, market watchers are closely looking out for any clues of a change of tack in the ECB policy. 

A hike in interest rates doesn’t seem to be on the agenda anytime soon, not least as inflation is not a problem. And so, the focus is on whether the ECB will further wind down its programme of asset purchases. 

It may be the case that it will have little option but doing so.

The rules governing the ECB QE programme clearly state that the ECB cannot buy more than 33% of government bonds from any of the eurozone countries. According to some market estimates the ECB may soon run out of government bonds to buy for a number of countries, particularly Germany. 

Faced with this situation, the ECB could relax the rules and increase the limit beyond 33% for all countries, thus preserving the current status quo in valuations. Theoretically, it could also exclude some countries from the programme, which would probably favour the peripheral countries.

However, this would be highly controversial, both economically and politically, as the ECB cannot be seen discriminating between countries. Finally, the ECB can further wind down – perhaps even put an end -  the QE programme. In that situation, the focus will be on whether peripheral bonds yields may rise fast once they lose the ECB support. 

Whatever the decision, it should have implications for eurozone fixed income valuations, particularly those from peripheral countries.  So, watch out for clues.

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Jose Garcia Zarate

Jose Garcia Zarate  is Associate Director of Passive Strategies Research for Morningstar Europe

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