With recovery lagging, Europe wary of rising interest rates

FRANKFURT (AP) — Prospects for a stimulus-fuelled recovery in the United States (US) are pushing up market interest rates — and that’s a headache for European policymakers because their economy remains stuck in a double-dip recession and can’t afford higher borrowing costs.

European Central Bank (ECB) President Christine Lagarde is expected to address rising bond yields. She holds a news conference after the bank’s 25-member governing council meets to decide monetary stimulus settings for the 19 countries that use the euro currency.

Here’s Lagarde’s problem: Interest rates on 10-year government bonds have risen by about 0.3 per cent since the start of the year. It’s regarded as a spillover from higher bond yields in the US. The higher US bond yields reflect expectations for stronger growth and inflation, following plans for a USD1.9 trillion stimulus bill pushed by new US President Joe Biden.

And those higher rates on US Treasurys are leading to higher yields on European bonds, too. The rise in European rates is not big, and it’s only taken rates to about where they were before the pandemic. Market interest rates are still very low by historical standards.

But it’s the wrong time for borrowing costs to be going up in Europe. The eurozone economy is expected to shrink over the first three months of the year and isn’t expected to reach pre-pandemic levels of output until 2022. That means Europe is lagging well behind the US, where the COVID-19 recession was shallower and the new administration’s stimulus efforts have raised hopes for a bounce-back this year.

The sun rises behind the buildings of the banking district in Frankfurt. PHOTO: AP

Reasons include Europe’s smaller fiscal stimulus in the form of relief payments to struggling businesses and workers, and the slower rollout of vaccinations which mean business closures and travel restrictions may remain in effect longer.

Lagarde could try to talk interest rates down by warning bond market participants that the ECB has plenty of tools available to intervene. Some analysts think she may go farther and lay out concrete steps that the bank could take, such as stepping up its ongoing bond purchases, which totalled EUR60 billion in February, to a higher figure, such as EUR80 billion per months.

That wouldn’t involve adding new stimulus, but more flexible use of the existing EUR1.85 trillion the bank plans to deploy through March 2022. Almost one trillion of that has not yet been used, meaning there is still significant monetary stimulus in the pipeline.

Bond purchases drive down market rates by pushing up the price of bonds, since price and yield move in opposite directions.

“While the US economy is in a position to deal with higher real yields, the eurozone economy is in a different situation,” said senior Europe economist at Berenberg bank in London Florian Hense. ECB officials have verbally warned markets in recent days that they don’t like the higher rates but talking may not be enough.

“Verbal intervention has bought the ECB time,” Hense wrote in an emailed analysis. “It is unclear how much more time the ECB has left before markets tests its resolve to put its money where it’s mouth is.”

The ECB is the monetary authority for the 19 of 27 European Union member countries that have joined the common currency. It plays a role analogous to that of the US Federal Reserve, the Bank of Japan or the Bank of England in the United Kingdom.

It can steer market interest rates in ways best for the economy, using short-term benchmarks such as its weekly lending to bank or intervening in the bond market to affect longer-term rates.