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Let's talk about bonds: Five questions for the ECB

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The European Central Bank meets on Thursday (11 March) and one topic will dominate: what to do about rising sovereign bond yields which if left unchecked could derail efforts to get a coronavirus-hit economy back on track, write Dhara Ranasinghe and Ritvik Carvalho.

Germany’s 10-year borrowing costs jumped 26 basis points in February, the biggest monthly rise in over three years, with similar moves seen across the euro area.

Policymakers from president Christine Lagarde to chief economist Philip Lane have expressed unease. Markets want to know the game plan.

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Here are five key questions on the radar.

1. What will the ECB do to contain rising bond yields?

The ECB shouldn’t hesitate to lift bond buying volumes and use the full firepower of the 1.85 trillion euro ($2.2 trillion) Pandemic Emergency Purchase Programme (PEPP) if needed, says board member Fabio Panetta.

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Economists agree but policymakers are divided. Just under 1 trillion euros of the PEPP is still unused. Buying slowed recently, perhaps due to technical factors.

Still higher government borrowing costs, threatening to spill over to corporates and consumers, create a headache for an ECB grappling with a weak economy.

“Is the ECB fully aware of the risks?,” said ING Research global head of macro Carsten Brzeski. “And if they are, are they willing to be more precise about what they are prepared to do -- will they act with advanced PEPP purchases?”

GRAPHIC: The ECB's pandemic stimulus programme

Reuters Graphic

2) What exactly is the ECB watching to assess financial conditions?

Lagarde will be pressed for clarity on this.

She has voiced concern about rising nominal yields. Remarks from other officials and the last ECB minutes put emphasis on the real or inflation-adjusted component of yields as a key determinant of financial conditions.

Both have risen this year, but real yields less so.

Lane focuses on the GDP-weighted sovereign yield curve and the overnight index swap (OIS) curve.

A clearer idea of which is key would give markets a better sense of policymakers’ pain threshold.

GRAPHIC: Which yield is key?

Reuters Graphic

3) How far does the ECB expect inflation to rise this year?

Accelerating inflation, which could exceed the near 2% target in coming months, means the ECB will likely increase its 2021 inflation forecast.

Lagarde may stress that a recent pick-up in prices is driven by one-off factors and should fall back.

But there are differing opinions among policymakers. Bundesbank chief Jens Weidmann believes the ECB will have to “act accordingly” if inflation rises.

“There are more mixed views on inflation - ECB staff and Lane think inflation is subdued but this is not shared by the hawks, with Weidmann recently highlighting that German inflation was likely to go through 3% this year,” said Jacob Nell, head of European economics at Morgan Stanley.

GRAPHIC: Accelerating inflation?

Reuters Graphic

4) What will the ECB say about the economic outlook?

Economists expect the medium-term outlook to remain broadly unchanged, with a recovery forecast in the second half of 2021.

Lagarde, however, may stress short-term downside risks as the bloc battles the coronavirus pandemic and lockdowns.

The economy is almost certainly in a double-dip recession as the services industry suffers, but hopes for a wider vaccine rollout has driven optimism to a three-year peak, a survey showed last week.

GRAPHIC: Eurozone economic surprises stay positive in 2021

Reuters Graphic

5) Is the ECB relieved that Draghi is Italian PM?

Lagarde is unlikely to comment on politics in Italy, where her predecessor Mario Draghi just became prime minister. But a fall in Italian borrowing costs on his appointment is good news and eases pressure on the ECB.

The Italian/German 10-year bond yield gap narrowed to the tightest levels since 2015 in February; recent bond turbulence hasn’t hurt too much.

The trusted Draghi has promised sweeping reforms to revitalise a battered economy. His strongly pro-European stance is seen as a positive for Italy and the euro project.

GRAPHIC: Italian bond spread during the COVID-19 crisis

Reuters Graphic

European Commission

NextGenerationEU: European Commission disburses €231 million in pre-financing to Slovenia

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The European Commission has disbursed €231 million to Slovenia in pre-financing, equivalent to 13% of the country's grant allocation under the Recovery and Resilience Facility (RRF). The pre-financing payment will help to kick-start the implementation of the crucial investment and reform measures outlined in Slovenia's recovery and resilience plan. The Commission will authorise further disbursements based on the implementation of the investments and reforms outlined in Slovenia's recovery and resilience plan.

The country is set to receive €2.5 billion in total, consisting of €1.8bn in grants and €705m in loans, over the lifetime of its plan. Today's disbursement follows the recent successful implementation of the first borrowing operations under NextGenerationEU. By the end of the year, the Commission intends to raise up to a total of €80 billion in long-term funding, to be complemented by short-term EU-Bills, to fund the first planned disbursements to member states under NextGenerationEU.

The RRF is at the heart of NextGenerationEU which will provide €800bn (in current prices) to support investments and reforms across member states. The Slovenian plan is part of the unprecedented EU response to emerge stronger from the COVID-19 crisis, fostering the green and digital transitions and strengthening resilience and cohesion in our societies. A press release is available online.

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Cyprus

NextGenerationEU: European Commission disburses €157 million in pre-financing to Cyprus

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The European Commission has disbursed €157 million to Cyprus in pre-financing, equivalent to 13% of the country's financial allocation under the Recovery and Resilience Facility (RRF). The pre-financing payment will help to kick-start the implementation of the crucial investment and reform measures outlined in Cyprus' recovery and resilience plan. The Commission will authorise further disbursements based on the implementation of the investments and reforms outlined in Cyprus' recovery and resilience plan.

The country is set to receive €1.2 billion in total over the lifetime of its plan, with €1 billion provided in grants and €200m in loans. Today's disbursement follows the recent successful implementation of the first borrowing operations under NextGenerationEU. By the end of the year, the Commission intends to raise up to a total of €80bn in long-term funding, to be complemented by short-term EU-Bills, to fund the first planned disbursements to member states under NextGenerationEU. Part of NextGenerationEU, the RRF will provide €723.8bn (in current prices) to support investments and reforms across member states.

The Cypriot plan is part of the unprecedented EU response to emerge stronger from the COVID-19 crisis, fostering the green and digital transitions and strengthening resilience and cohesion in our societies. A press release is available online.

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Belgium

EU Cohesion policy: Belgium, Germany, Spain and Italy receive €373 million to support health and social services, SMEs and social inclusion

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The Commission has granted €373 million to five European Social Fund (ESF) and European Regional Development Fund (ERDF) operational programmes (OPs) in Belgium, Germany, Spain and Italy to help the countries with coronavirus emergency response and repair in the framework of REACT-EU. In Belgium, the modification of the Wallonia OP will make available an additional €64.8m for the acquisition of medical equipment for health services and innovation.

The funds will support small and medium-sized businesses (SMEs) in developing e-commerce, cybersecurity, websites and online stores, as well as the regional green economy through energy efficiency, protection of the environment, development of smart cities and low-carbon public infrastructures. In Germany, in the Federal State of Hessen, €55.4m will support health-related research infrastructure, diagnostic capacity and innovation in universities and other research institutions as well as research, development and innovation investments in the fields of climate and sustainable development. This amendment will also provide support to SMEs and funds for start-ups through an investment fund.

In Sachsen-Anhalt, €75.7m will facilitate cooperation of SMEs and institutions in research, development and innovation, and provide investments and working capital for micro-enterprises affected by the coronavirus crisis. Moreover, the funds will allow investments in the energy efficiency of enterprises, support digital innovation in SMEs and acquiring digital equipment for schools and cultural institutions. In Italy, the national OP ‘Social Inclusion' will receive €90m to promote the social integration of people experiencing severe material deprivation, homelessness or extreme marginalisation, through ‘Housing First' services that combine the provision of immediate housing with enabling social and employment services.

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In Spain, €87m will be added to the ESF OP for Castilla y León to support the self-employed and workers who had their contracts suspended or reduced due to the crisis. The money will also help hard-hit companies avoid layoffs, especially in the tourism sector. Finally, the funds are needed to allow essential social services to continue in a safe way and to ensure educational continuity throughout the pandemic by hiring additional staff.

REACT-EU is part of NextGenerationEU and provides €50.6bn additional funding (in current prices) to Cohesion policy programmes over the course of 2021 and 2022. Measures focus on supporting labour market resilience, jobs, SMEs and low-income families, as well as setting future-proof foundations for the green and digital transitions and a sustainable socio-economic recovery.

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