The European Central Bank has indicated that there will be no rises in interest rates in the near fu...
The European Central Bank has indicated that there will be no rises in interest rates in the near future even though an inflationary threat has emerged.
'Recently the performance of European bonds has been poor,' said John McNeill, investment manager at Brittanic Asset Management. 'We have seen the yield falling from the end of March to May. The US bond market set the tone for the European market.'
The European Central Bank, which uses inflation not growth targets as the touchstone of monetary policy, has been clear, McNeill says.
'The ECB has shown concern about the rate of inflation in the European states,' says McNeill. 'There is a difference between the Federal Reserve and the ECB, The Federal Reserve focuses on growth whereas the ECB has inflation as its objective.'
John Hamilton, head of Fixed Interest at Jupiter Asset Management, explains the impact on bonds if inflation rises: 'Because fixed rate bonds have fixed payments, if inflation rises, it erodes the real value of these payments.' 'However, I don't think that there is any chance of interest rates rising, because the ECB has also said that it views the current rate as a fair one,' says McNeil.
'But they admit that the change to the euro earlier this year led to an increase in inflation. Moreover oil prices have been on the rise and there have been wage negotiations in some European states that have pushed prices up. The ECB has a very strict mandate to keep inflation below 2%.'
Hamilton says that money market futures have already priced in 1% in rates at the end of the year, indicating that the market thinks that there might be an increase in rates, in clear opposition to the ECB's stated intention.
There is still a chance that inflationary pressures in Europe will be offset by global factors. 'The global market is proving to be very price competitive, this might offset inflationary pressures,' says Hamilton. 'Moreover, the euro has been quite strong this quarter and this might mitigate the need for a rate rise. Also the currency itself can dampen inflation as the euro might bring increased competition to the region lowering prices and wages.'
'In November and December last year, bond markets fell heavily,' says McNeill. 'At the beginning of the year, we saw bond markets digesting the fall. In January, German 10-year bonds had a yield of 5%, now they have one of 5.25%. The yield is rising because the market has a more optimistic view on global growth as the US econ- omy has shown some resilience. As regards future growth, there is less optimism about inflation and interest rates leading to a higher bond yield.' The eurozone has very little flexibility and has to abide by strict policies, with different economies within the zone it is difficult for the ECB to manage.
'Different economies within the ECB have different growth rates and budget deficits. Germany, Italy and Portugal are going off target with their deficit. This makes it difficult for the ECB to control,' says Hamilton.
'Moreover, the eurozone is a highly regulated region therefore the market is less responsive to monetary policy targets and growth. The ECB is urging economies to improve labour flexibility so that growth can be encouraged.'
European yields are rising.
Interest rates unlikely to rise soon.
Competition bringing lower wages.
Two global vehicles
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Must appoint separate CEOs and boards
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Will report to Mark Till