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The European Central Bank is challenged by the latest rise in US bond yields on Trump-led reflation expectations. EU rates were not spared from rising global yields, which in turn, have raised doubts over the ECB’s quantitative easing program.
Mirroring the surge in US yields, the EU 10-year bond yield has risen to 0.30 percent on November 15 from 0.19 percent on Nov 8. More importantly, this yield has ceased to be negative since early-October. Over the past week, expectations have increased for fiscal stimulus to overtake monetary policy in supporting growth, DBS reported.
Against this backdrop, the ECB will need to provide clarity on their policy guidance. In the past week, policymakers reiterated their dovish stance to temper the rise in bond yields (and borrowing costs), so not to blunt efforts to stimulate the economy.
Domestic factors continue to support the Eurozone economy. Consumption is benefitting from easing unemployment rates and low inflation. The modestly wider fiscal deficit in 1Q16 may be signaling a let-up in fiscal austerity. However, external factors seem less favorable. Exports and imports extended their declines. Support from exogenous factors such as low oil prices, a weak euro and easy monetary policy are also likely to wane.
"We expect the ECB to keep its rhetoric dovish and announce an extension in the QE purchases at the December meeting. The differentiating factor, however, will be the quantum of purchases, where we now expect a modest cutback," DBS commented in the report.
Meanwhile, a push for more fiscal support will continue, but the precedent of high sovereign debt levels and resultant crisis, raises the hurdle for a looser fiscal policy.
