It’s not all about the ECB, and the rise in long yields should soon be over

It is now almost certain: judging by the minutes of the ECB’s most recent monetary policy committee meeting, Mario Draghi’s comments during the Sintra forum on 27 June were no accident, but carefully devised to counter the embarrassing flattening of the yield curve in the previous few weeks. That subject is where the 8 June minutes begin, suggesting that there was an intense debate about what most members of the monetary policy committee regard as an anomaly. At a time of rising confidence in the economic outlook, the ECB was clearly expecting the yield curve to steepen, particularly after the French elections removed the main political risks.

The curve flattening was caused by a significant fall in long yields, which not only wrong-footed the ECB but was clearly an unhelpful development at a time when the ECB was preparing to adjust the direction of its monetary policy, as the minutes clearly show. The possibility that the markets would overreact to the ECB’s downgrade of its 2017 inflation forecast, to 1.5 % in June from 1.7 % in March, was probably one of the reasons behind Mr Draghi’s comments of 27 June, when he reassured the market that inflation would continue to rise gradually and played down the reduction in the ECB forecast, which he attributed to volatility in oil prices.

His strategy worked well. Since his speech, the 2/10-year German yield spread has risen almost 20 basis points, with the jump in 10-year yields being followed by increases across all other maturities. Inflation expectations, which had fallen back after rebounding briefly following the first round of the French election, have risen again, although they are still short of levels seen in early May.

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