Yield Outlook:10Y Bund yields set to remain close to zero through 2019
|In the previous issue of Yield Outlook, 13 March, we argued that the ECB would help keep short and long yields low – and close to current levels – for the remainder of 2019. First, the ECB extended its forward guidance, definitively closing the door on any potential rate hike in 2019. Second, the central bank opted to launch a series of new long-term loans for European banks (TLTROs) when the existing loan programme expires later this year. The programme is partly to ensure that Italian banks in particular would not experience funding problems in coming years. Third, the ECB clearly signalled an easing bias. The ECB is thus prepared to take further measures if the economy fails to recover. We have made no major changes to our yield forecasts in this issue of Yield Outlook. If anything, we are now even more certain that both short-term and long-term rates are set to stay low for the rest of 2019 and far into 2020.
ECB concerned about ‘negative effects’ of negative interest rates
First of all, the ECB took another step forward during the past week. At a conference, Draghi announced that the ECB is looking into measures to soften the impact of negative interest rates on earnings in many European banks. At the end of the day, the large excess liquidity created by previous bond purchases in the financial system must be placed with the ECB at minus 0.40%. Since the banks broadly offer zero rather than negative interest rates especially on household deposits, their interest margins have narrowed substantially, eroding bank earnings. There are fears that this extra cost could ultimately make it difficult for banks to expand lending operations, and negative interest rates may therefore have the opposite effect of the one intended and act as on obstacle to economic growth.
One potential measure would be to allow banks to avoid a negative interest rate on the part of the excess liquidity that is currently placed at minus 0.4% with the ECB. Such a tiering system is already in use in Denmark, Switzerland and Japan. We do not expect such a system to necessarily lead to a lending boom from European banks. But it would send a clear signal that the ECB is looking for ways to change the system (although this was found too complex to do back in 2016) because it is well aware that negative interest rates are set to persist for a very long time – potentially for many years. In principle, tiered interest rates would also make it easier for the ECB to further reduce the lowest or marginal rate of interest. The ECB’s key policy rate is ‘only’ minus 0.4%. Policy rates in Denmark and Switzerland stand at minus 0.65% and minus 0.75%, respectively. A tiering system for overnight deposits with the ECB would, not least, benefit German banks, as they have large household deposits. So, one could say that there is something in it for the Germans, given that the TLTROs have mainly targeted southern Europe.
German economy set to remain sluggish
Second, and even more importantly, the European economy has remained decidedly sluggish, forcing the ECB to keep rates low for a very long time. PMI figures dropped further in March from an already recessionary 49.3 to a six-year low of 47.5. The overall PMI index was pulled lower in particular by a fall in the important ‘new orders’ index
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