Sunday, May 24, 2015

ECB calms bond market - end extreme behavior



One of the reasons given for the EU bond market sell-off has been the view that the ECB will not follow-through on their QE program of consistent monthly buying of 60 billion euros in bonds. The ECB has had to send signals that it will continue to act regardless of current growth and inflation numbers. On the 15th ECB president Draghi said that ECB stimulus will last "as long as needed". 

"While we have already seen a substantial effect of our measures on asset prices and economic confidence, what ultimately matters is that we see an equivalent effect on investment, consumption and inflation, ... We will implement in full our purchase program as announced and, in any case, until we see a sustained adjustment in the path of inflation," 
This is a clear monetary announcement with no ambiguity. We can call this true monetary transparency. ECB has also sent signals to the market that it will front-load some of its purchases that were to occur in the summer. It is doing this so as not to disrupt the markets during the summer season, but it is a clear means of reducing the markets sell-off.

Finally, this week-end President Draghi argued for structural reform in Europe for labor markets to lower unemployment. This is an important point often missing with policy-makers. Monetary policy provides for a better environment for reform and should not be the sole catalyst for growth. 

Should rates move higher under the assumption that demand will increase, growth with improve, and inflation will be higher? The answer is yes. Should there be a bond sell-off because the ECB is not resolved to buy bonds and continue its policies? The answer is no.

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