Europe’s Low Yields Are Here to Stay as Inflation Outlook Turns

The outlook for euro-area inflation is souring and that suggests record-low yields on the region’s government bonds aren’t going away anytime soon.

Forget the debate over when the Federal Reserve will raise interest rates, disregard how soon after that the Bank of England will move, yields in the euro area are likely to remain subdued as the region fends off disinflationary pressures.

Slower inflation is good news for bondholders because it preserves the purchasing power for fixed payments on their securities. In an additional boon, the European Central Bank’s extraordinary stimulus to combat disinflation includes a 1.1 trillion-euro ($1.2 trillion) bond-buying program known as quantitative easing.

Falling oil prices have been responsible for much of the recent plummet in consumer-price growth and the effects will linger for longer as commodity prices renew their decline.

That’s part of the reason ECB President Mario Draghi’s preferred measure of the region’s inflation outlook has taken a turn for the worse in recent weeks.

“One of the things the ECB wanted to do once they rolled out QE was obviously drive the inflation expectations upward,” Peter Schaffrik, head of European rates strategy at Royal Bank of Canada in London, said in an interview on Bloomberg Television’s “On The Move” with Jonathan Ferro. “If we don’t manage to at least get some kind of inflation expectations back in the market I’m afraid nominal yields will stay where they are.”

The average yield on euro-area sovereign debt was at 0.83 percent on Thursday, according to the Bloomberg Eurozone Sovereign Bond Index. It declined to 0.48 percent in March, the lowest on record. The average yield since 2010 was 2.46 percent.

The diminished outlook for consumer-price growth means investors are now paying the most since January to protect against deflation.

In a summary account of the central bank’s most recent policy meeting, officials said they were ready to tweak their QE program if needed to respond to global market volatility amid “unusually low” inflation and “disappointing” economic growth. Data on Friday showed consumer prices increased 0.2 percent in July from the same time a year ago, versus the ECB’s goal of just below 2 percent.

The ECB began buying sovereign debt in March with the intention of boosting its balance sheet back to 2012 levels. The extra demand for bonds will also put pressure on yields as the central banks vies with investors for holdings.

The ECB won’t reach its inflation mandate for five more years, according to a survey of professional forecasters conducted by the central bank.

 

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