ECB’s Knot: Recent Increase in Yields Largely Driven by Benign Factors

27 March 2021

By David Barwick – FRANKFURT (Econostream) – The increase this year in euro area long-term yields mainly reflects ‘benign’ developments, European Central Bank Governing Council member Klaas Knot said Saturday.

Speaking during a virtual panel of a CF40, Euro50 Group and PIIE conference, Knot, who heads the Dutch National Bank, argued that ‘[n]ot every rise in yields is inconsistent with our pledge to maintain favorable financing conditions’ and that in particular, ‘a rise in nominal rates due to better growth and inflation prospects may not cause immediate worries.’

‘In contrast, rising interest rates due to, for example, dysfunctioning markets warrants a corresponding policy intervention’, he added.

‘The recent increase in yields was largely driven by benign factors’, he said. ‘Taken at face value, the rise in inflation expectations is a welcome development.’

Still, he conceded, ‘the sizeable and persistent rise in euro area yields due to a faster economic recovery in the U.S. could prematurely tighten financing conditions for the euro area economy, which is inconsistent with countering the downward impact of the pandemic on the projected path of inflation.’

That is why the Governing Council decided on March 11 to pick up the pace of asset purchases ‘until the improved growth outlook for the euro area itself would stand on firmer ground’, he said. Although this has ‘neutralised’ upside pressure on yields, he said, ‘it is important to note that we stand ready to adjust our monthly purchases in either direction, if required, to maintain favourable financing conditions.’

Knot argued that the rise in euro area long-term yields ‘reflects, at least in part, spillovers from the U.S. arising from the improved prospects for global growth.’ In particular, he said, U.S. macroeconomic developments and U.S. policy ‘are driving factors’ that ‘turn positive in early January when the Democrats gained control over the Senate by the surprise win in Georgia.’

‘As of that moment, the expectations surrounding the size of a potential fiscal package have significantly grown, which resulted via both the U.S. macro and U.S. policy component in upward pressure on euro area yields’, he said.

A third factor behind higher euro area long-term yields is diminished global risk, where, ‘against the backdrop of an improved economic outlook, investors increasingly switch from fixed income into more risky asset classes’, he said.

Higher oil prices in the context of brighter global economic prospects are also a factor, he said. ‘The dominance of demand-side factors behind the rise of oil prices confirms that the improving economic outlook is an important driver’, he said. ‘Driven by the rising oil prices and the improving outlook, market-based measures of inflation expectations have surged as well’.