Central Banking Insights: ECB and Yield Curve Targeting?

In an interview at the beginning of 2021, the Head of the Spanish central bank brought into play the fixing of government bond yields. In the euro area, this would be another step that monetary policy wants to support not only inflation targeting but also fiscal policy with artificially low yields. However, we consider yield targeting to be impractical in the euro area.

ECB: Too much yield volatility with Quantitative Easing (QE) in the euro area?

Spanish central bank chief Pablo Hernandez de Cos reignited the discussion on ECB monetary policy on 4 Jan 2021 with a statement:

"I think controlling the yield curve is an option worth exploring".


Normally, monetary policy acts directly on short-term interest rates and only indirectly on medium and longer maturities of the bond market. For 6 years now, the European Central Bank (ECB) has practised quantitative easing (QE) on a grand scale. In the course of the financial and sovereign debt crisis of 2008, the US Federal Reserve decided to use this as "unorthodox" means because nominal interest rates had reached close to zero and the opinion prevailed at the time that negative interest rates were not a suitable means of monetary policy. Apropos, this opinion is still held by the US Federal Reserve today.

SMP, OMT, APP and PEPP: minus 100-200 basis points in benchmark yields

However, as early as 2008 the ECB expanded its monetary policy instruments to include specific bond-buying programmes (Securities Markets Programme SMP & Outright Monetary Transactions OMT) as a precursor to large-scale bond purchases. However, it was only after the euro crisis and the lowering of the deposit facility below the 0% mark in 2014 that a significant "Asset Purchase Programme" (APP) was developed. In January 2015 the APP was announced. In the run-up to the Greek crisis, ECB chief Mario Draghi had justified this implementation with the prevention of deflation and recession. The deeper background, however, was to avert sharply diverging risk premiums on bonds from different member states. With the purchase of government and private-sector bonds, it was the clear intention of the ECB to move the entire yield curve noticeably downwards. To this end, bonds with the desired maturity are acquired accordingly. Since March 2020, the ECB has already gained an even more dominant influence on the yield curve with the PEPP (Pandemic Emergency Purchase Programme) due to the flexibility in purchasing. Nevertheless, there are still slight, albeit small, yield movements in the various maturities. These are somewhat greater for longer maturities over 10 years than in the middle segment. All in all, the ECB's bond purchases under APP and PEPP — in combination with negative interest rates and the forward guidance — are already pushing the benchmark yield curve in the euro area down by 100 to almost 200 basis points (bp) from the 2- to 10-year maturity range (depending on the maturity range).


Yield on 10-year Austrian government bonds (%)

Source: Refinitiv, RBI/Raiffeisen Research

Low free float, low yield fluctuations already today ... and for longer

What is clear is that the ECB is shifting its remit of price stability in favour of supporting fiscal policy and thus contributing to reflation. Here the ECB is taking its cue from the macroeconomic constellation in the USA and the Federal Reserve. The problem with yield curve management in the euro area, however, is twofold. On the one hand, there is not one EUR yield curve, but 19 different ones for the respective member states. And on the other hand, the respective EUR central banks would be challenged here, as is already happening with the other bond-buying programmes. And here there are certainly different positions of the national central banks. It is conceivable that the German, Austrian or Dutch central banks could be sceptical about the plan to fix yields. But if yield targeting is not practised by all euro central banks, the concept is practically unworkable. So it will take at least until the publication of the ECB's revised monetary policy strategy in summer 2021 for more clarity on this. From today's perspective, however, the probability of a common line on yield fixing seems low. Especially since yield fluctuations have declined significantly since 2015 (introduction of the APP). The position of the ECB central bank system on the European bond markets has become increasingly dominant. The free float in European government bonds has decreased by 25-30 percentage points since then. This also means that yield fluctuations are becoming smaller and smaller, and the trading patterns of government bonds compared to other asset classes are increasingly changing. We think that above all the questions of the amount and length of the ECB bond purchase programmes (including the associated reinvestments) should move bond yields more in the coming years than the discussion about yield fixing. Without active balance sheet reduction and depending on further bond purchases, the ECB could distort benchmark rates downwards by around 60-100 basis points until well into the 2030s. However, we have of course taken the fact of low yield volatility into account in our (long-term) EUR yield forecasts.

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Gunter DEUBER

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Gunter Deuber is heading the Economics and Financial Analysis division (Raiffeisen Research) at Raiffeisen Bank International (RBI) since 1 January 2021. Since 2011, Gunter Deuber has held leading positions in RBI's Economic and CEE Research and has continuously expanded the cooperation with his research colleagues in RBI’s subsidiary banks in CEE. Since the early 2000s, he has been analysing economies, banking sectors and market topics with a focus on CEE and EU/euro area topics for RBI in Vienna, but also in the international (investment) banking context in Frankfurt. He regularly presents the views of Raiffeisen Research and his research team at meetings with investors and clients. He is a well sought-after speaker at landmark events in the finance and banking industry and a guest lecturer at several universities/teaching institutions. In 2019, he was nominated for the US State Department's IVLP (International Visitor Leadership Program). Gunter has published several edited volumes on Euro/EU crisis issues and published various articles in professional journals and industry magazines. Outside the office, Gunter enjoys travelling with his family and long-distance running.


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Peter BREZINSCHEK

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Peter Brezinschek is acting as Chief Analyst in Raiffeisen Banking Group since 1985. From 1999 to 2020 he was Global Head of Raiffeisen Research. In 1992 he founded the CEE analysis activity in Austria and locally in Central & Eastern European units. Since 2002 he has bundled all economic and financial analysis of the Raiffeisen Banking Group under the brand name “Raiffeisen Research”. He has worked as a co-author on several specialist books and regularly gives public lectures on economics and financial market topics. Active as an expert in the Austrian Fiscal Council for 20 years. The principal interests are ordo-liberalism & economic policy in the context of climate change, the business cycle development as well as monetary & fiscal policy. In his private life he likes to do all kinds of sports to enjoy nature and stay fit. Personal passion is financing tree planting in the City of Vienna.