The Irish government’s cost of borrowing in bond markets approached its highest level in eight years on Wednesday ahead of a much-anticipated meeting of the European Central Bank’s governing council.
he meeting is expected to pave the way for the first interest rate hike in more than a decade in July and an end to quantitative easing in an effort to calm inflation.
The yield on Irish 10-year government bonds hit 1.94pc on Wednesday, the highest since August 2014. The National Treasury Management Agency (NTMA) borrowed 3.5 billion euros on 13 January from an interest rate of only 0.387 pc.
The euro strengthened and yields rose in the bond market ahead of a pivotal ECB meeting.
In the bond market, investors have forecast a 37 basis point rise, which effectively means an even split between those betting it will be 25 basis points (a quarter of one percent) in July and September or a single 50 basis points (half of a percent) move next month, according to Ryan McGrath, head of fixed income strategy and sales at Cantor Fitzgerald.
The new quarterly economic forecasts prepared for the ECB meeting will also be a focus, he said.
“If growth is weaker and inflation higher than previously forecast, that would warrant more urgent action,” he said.
A key thing to watch is whether the two-year forecast puts inflation then above the ECB’s preferred 2% rate, which would warrant a more aggressive move to contain it now, he said. .
Analysts and investors will be watching Christine Lagarde’s language for signs that so-called ECB hawks who favor a sharper response to inflation have gained influence over Dovish proponents of a more gradual approach, including Chief Economist Philip Lane.
The initial rate hike is expected to focus on the so-called deposit rate that the ECB charges banks for holding cash, but the so-called refinance rate – the benchmark interest rate at which mortgage payments tracking are linked – should increase either at the same time or shortly thereafter. This has a direct impact on tens of thousands of borrowers here.
The deposit rate is currently -0.5 pc. Policy makers want to bring this down to zero at least when they “normalize” policy. The refinancing rate is already at zero and it’s up to the ECB to maintain a gap between the two, then move in tandem or move one and not the other, said chief economist at Davy Stockbroker , Conall MacCoille.
Before interest rates rise, policymakers should approve an end, perhaps immediately, to their massive and long-lasting purchases in the bond market, or quantitative easing (QE) – which has been in effect in various forms for most of the past decade. QE was launched to stimulate growth and prevent deflation after the debt crisis.
“It’s hard to see why an inflationary policy hasn’t already been stopped,” Mr MacCoille said.
However, he said policymakers will be aware of the risk that a complete withdrawal of post-financial-crisis support could leave Italy heavily indebted particularly exposed in the bond market, he said.
Italy’s borrowing costs have already risen above 3%.