Any European Central Bank move to print money could raise investors' expectations for euro zone inflation and growth, pushing German Bund yields higher and potentially halting a two-year-old rally in peripheral debt.
Euro zone bonds have gained in recent weeks on growing expectations the ECB will eventually start buying government debt with new money to help bring inflation back to its target of just under 2 percent from 0.7 percent in April.
The central bank would have to pay a high price for those bonds and investors are buying them now with a view to selling them to the ECB for a profit later.
But if the ECB embarked on a programme of quantitative easing, or QE, investors would then have to consider that it was intended to boost longer-term inflation and growth and yields on benchmark 10-year bonds would have to adjust higher.
"If you start credible QE the market has to price a non-zero probability it would work, and that means Bund yields would rise," said Laurence Mutkin, global head of G10 rates strategy at BNP Paribas.
He said any QE would also raise the floor for yields on debt issued by fragile euro zone economies. While the gap between Bund yields and peripheral yields could narrow, outright peripheral yields "had less scope to fall".
Marco Brancolini, rates analyst at RBS, said bond yields also rise when central banks launch bond-buying programmes because investors tend to see it as the final act in a monetary policy easing cycle.
"Once the easing cycle bottoms down, the market has no more easing information to price in and starts looking forward to the hiking cycle," he said.
ECB policymakers have said QE is a possibility but that any programme remains far off and could be tricky to design given the peculiarities of the currency union.
Reuters reported last week that the ECB is preparing a package of policy options for its June 5 meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.
Whether markets perceive an ECB QE programme to be credible or not mainly relates to its size. Analysts at major banks work with scenarios ranging from the ECB spending a few hundred billion euros to more than 1 trillion euros on government bonds and other assets.
Taking the third U.S. QE programme as a benchmark and adjusting it for the smaller euro zone economy, the Bruegel think-tank proposes the ECB should start with a 35 billion euro a month programme, which should be revised every three months.
Anything smaller may be seen as "too timid" by the market, Bruegel said in a research paper.
Michael Krautzberger, who heads the euro fixed income team at BlackRock, also said size matters.
"The stronger the stimulus is and the more credible the ECB is viewed by market, the higher the chance that longer dated inflation expectations pick up and Bund yields rise modestly."
Source: Reuters
Euro zone bonds have gained in recent weeks on growing expectations the ECB will eventually start buying government debt with new money to help bring inflation back to its target of just under 2 percent from 0.7 percent in April.
The central bank would have to pay a high price for those bonds and investors are buying them now with a view to selling them to the ECB for a profit later.
But if the ECB embarked on a programme of quantitative easing, or QE, investors would then have to consider that it was intended to boost longer-term inflation and growth and yields on benchmark 10-year bonds would have to adjust higher.
"If you start credible QE the market has to price a non-zero probability it would work, and that means Bund yields would rise," said Laurence Mutkin, global head of G10 rates strategy at BNP Paribas.
He said any QE would also raise the floor for yields on debt issued by fragile euro zone economies. While the gap between Bund yields and peripheral yields could narrow, outright peripheral yields "had less scope to fall".
Marco Brancolini, rates analyst at RBS, said bond yields also rise when central banks launch bond-buying programmes because investors tend to see it as the final act in a monetary policy easing cycle.
"Once the easing cycle bottoms down, the market has no more easing information to price in and starts looking forward to the hiking cycle," he said.
ECB policymakers have said QE is a possibility but that any programme remains far off and could be tricky to design given the peculiarities of the currency union.
Reuters reported last week that the ECB is preparing a package of policy options for its June 5 meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.
Whether markets perceive an ECB QE programme to be credible or not mainly relates to its size. Analysts at major banks work with scenarios ranging from the ECB spending a few hundred billion euros to more than 1 trillion euros on government bonds and other assets.
Taking the third U.S. QE programme as a benchmark and adjusting it for the smaller euro zone economy, the Bruegel think-tank proposes the ECB should start with a 35 billion euro a month programme, which should be revised every three months.
Anything smaller may be seen as "too timid" by the market, Bruegel said in a research paper.
Michael Krautzberger, who heads the euro fixed income team at BlackRock, also said size matters.
"The stronger the stimulus is and the more credible the ECB is viewed by market, the higher the chance that longer dated inflation expectations pick up and Bund yields rise modestly."
Source: Reuters
