Negative German Yields Are Evidence of ECB Exhaustion
Germany this week joined the elite club of sovereign borrowers able to raise funds for a decade at an interest rate of less than zero. Other euro zone countries, including France, Spain and Italy, are also enjoying 10-year borrowing costs at or near record lows. Negative German yields are the strongest signal yet that the European Central Bank is failing in its quest to revive the animal spirits that would drive inflation back to its 2 percent target.
Here's the journey taken by euro government borrowing costs since the beginning of 2013:
The yield on the 10-year German bund dipped to a record low of minus 0.038 percent on Thursday, two days after going negative for the first time ever. In part, the move reflects safety-seeking by investors concerned about next week's U.K. vote on European Union membership. But it also reflects a wider post-credit crunch malaise. "If one wanted a simple indicator to reflect a broken financial system, then this would be a strong candidate," says Jim Reid, Deutsche Bank's global head of credit strategy. To put it bluntly, quantitative easing is failing.
There's a growing consensus that the law of diminishing returns is kicking in with regard to the ECB's efforts to reanimate the euro zone economy. After stepping up its bond-buying program to 80 billion euros ($90 billion) per month, the central bank's balance sheet is poised to reach a record:
But ECB President Mario Draghi's favorite measure of inflation expectations -- the five-year, five-year forward inflation swap rate -- has just dropped to a record low of 1.35 percent, far below the central bank's 2 percent target rate:
That chart suggests the outlook for euro zone inflation is getting worse, not better. Consumer prices fell for a second consecutive month in May, declining by 0.1 percent. The average annual inflation rate for the past three years is just 0.4 percent, meaning the threat of deflation remains alive. And as Draghi himself has noted, the credibility of a central bank depends on meeting its mandate.
To be fair to the central bank chief, there's only so much monetary policy can do on its own. It's not as if European officials don't acknowledge the need for infrastructure investment as a catalyst for faster growth. European Commission President Jean-Claude Juncker introduced a program specifically to tackle the issue. His European Fund for Strategic Investments is designed to provide capital of 21 billion euros, leveraged 15/1 by drawing in accompanying private funds that would deliver total investments worth 315 billion euros.
Thus far, though, the fund has signed commitments worth just 1.8 billion euros, even though it was unveiled in 2014 and has been up and running for about a year. Euro zone governments need to step in add some fiscal firepower to the ECB's efforts, as Draghi keeps begging them to do. So there's a great opportunity being squandered to borrow the cheapest money ever to invest in European growth. The ultra-low borrowing costs available in the government bond market should persuade the euro zone's leaders to step in and ease the burden that's currently being carried by the ECB alone.
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