Lex: European bonds
Published: June 16 2002 20:32 | Last Updated: June 16 2002 20:32
Who's in charge, central bankers or the bond market? The declines in European bond yields may stem chiefly from the exodus from equity markets, just as they have in the US. But they ignore at their peril hawkish noises coming from the European Central Bank and the UK Monetary Policy Committee. Beware: hawks have sharp claws.
That US bonds should be retracing their steps is less of a surprise. Treasury bonds had sold off, prematurely, on expectations of a more robust recovery. There are few signs of inflation, bar the gold price, and the Federal Reserve is highly sensitive to slumping equity markets. Rates appear on hold.
In the UK and eurozone, conditions are not as supportive. Rising house prices are alarming the Bank of England, and its 2.5 per cent target for underlying inflation is under long-term threat. Sterling's fall has further loosened the monetary stance. Yet implied yields on December interest rate futures have fallen from 5.2 to 4.9 per cent in a month, against base rate forecasts up to 6 per cent. Equity markets, meanwhile, are unlikely to stay the BOE's hand unless they crash. So far this year, falling equity values have been more than offset by rising house prices.
In Europe, the ECB is under less pressure to raise rates. Inflation may be above target, but a 5 per cent rise in the trade-weighted euro adds some 50 basis points of tightening. Still, the falling December Euribor rate underestimates the rate rise risk by year end. Central bankers may be willing to overlook that while markets are roiled. But eventually they will reassert their authority.