A volatile reaction in bond prices could be sparked in Europe and could also spillover throughout the continent if there is a revival of reflationary pressures in the U.S., said the European Central Bank vice-president Vitor Constancio during a TV interview on Wednesday.
Evidence of the potential turbulence that could envelop some euro zone sovereigns has been exhibited by the sudden surge in bond yields after November’s U.S. election, Constancio pointed out. “That is the risk… it is the materialization of this reflation narrative,” he said on Wednesday.
Stocks that could stand to benefit from higher inflation and yields are referred to the reflation trade. After he pledged to enact an agenda that included lower corporate taxes and infrastructure spending, investors and traders had been betting on rising inflation under Donald Trump’s presidency.
He was careful not to undermine the significance of an economic recovery, particularly in Europe even while Constancio admitted a “Trump rally” currently appeared less likely than in January.
“What is still ongoing is an economic recovery which is not so buoyant as markets thought some time ago but it is, nevertheless, a recovery,” he added.
ECB ‘should err on the side of caution’
The ECB suggested debt sustainability concerns had increased over the past six months amid a possible uptick in yields as it published its latest financial stability report on Wednesday.
“Risks to financial stability stemming from financial markets remain significant,” the Frankfurt-based institution said in its review. The ECB added a bond market re-pricing could “materialize via spillovers from higher yields in advanced economies, in particular, the United States.”
With the intention to discuss whether to taper its massive quantitative easing (QE) program, policymakers at Europe’s central bank are poised to begin talks over the summer. The purchases of ECB’s assets resume at a rate of 60 billion euros ($67 billion) each month at present.
It would be best practice for the ECB to tread carefully when considering amending monetary support, Constancio stressed that, from his perspective. However, given the strengthening economic growth in the region, some on the central bank’s governing council are more disposed to reining in QE.
“If anything… if we have to err to (avoid) making a mistake, and I hope we don’t make a mistake, but if we have to err we should then err in the direction of being cautious,” he said.
‘Never boring’ at the ECB
Constancio is due to stand down in June 2018 and had begun working as ECB vice-president in 2010. He suggested the excitement and importance of such role meant his tenure was “never boring” having aided the central bank during various so-called crises.
(Adapted from CNBC)