Sunday 26 January 2020

Government borrowing costs plunge as investors bank on QE

Mario Draghi and Janet Yellen
Mario Draghi and Janet Yellen
Donal O'Donovan

Donal O'Donovan

The Irish Government's cost of borrowing on the markets has fallen to an all time low, as investors bet that the European Central Bank (ECB) will launch a programme to buy up masses of bonds in an effort to pull the economy out of a deflationary slump.

Plunging borrowing costs are good news for the Government here - and make its plan to save €375m a year by replacing costly IMF rescue loans with new bonds even more compelling.

But, the good news for the Government really reflects alarm at the ECB about the weakness of the economy across the wider euro area.

The price paid on the markets for European government bonds surged, pushing yields from Germany to Ireland and Spain down to new records, after ECB President Mario Draghi gave his strongest signal yet that officials are moving closer to so-called quantitative easing (QE) in a speech late on Friday .

"The view now is that the ECB is going to act sooner rather than later. Mario Draghi had hinted at QE in the past but he has yet to deliver, that's what is driving the reaction," said David McNamara, an economist at Davy.

QE, is regarded as a radical step to re-inflate the economy by having the central bank print money to essentially manufacture demand, including for bonds. It has already been used in the UK and the US in the wake of the financial crisis.

The idea is that the action can reinvigorate the economy and counter the risk of falling asset prices becoming a self-fulfilling vicious cycle.

At his speech on Friday, delivered at an annual conference of central bankers at the US resort of Jackson Hole, Mr Draghi admitted that prices have been weak in the euro zone, and not just because of one-off shocks such as the Ukraine crisis.

"Factory gate prices have been negative for the past three months, suggesting the pipeline is weak," said David McNamara.

The interest rate on 10-year Irish government bonds dropped to barely more than 1.8pc. That compares to interest rates of as much as 5pc being paid under the bailout.

Bond yields fall if demand for the bonds themselves goes up. On Monday investors raced to buy bonds, betting that the ECB's plans will support prices.

Rates on 10-year Italian and Spanish securities, as well as German five-year and Austrian 10-year bonds, reached the least since Bloomberg started collecting the data, while Belgium's two-year yield went negative for the first time. Bets on price increases in the euro area have "exhibited significant declines," Mr Draghi said.

Even French borrowing costs fell, on a day the French President Francois Hollande ordered the dissolution of the government there.

At the Jackson Hole event Mario Draghi said his bank was prepared to respond with all its available tools should inflation in the euro zone drop further.

With interest rates already at an all-time low investors are betting that means asset purchases, or other stimulus measures.

While it is a boost for bonds, creating ever more money should depress the value of the euro.

Yesterday the euro fell to $1.3185 against the doller, its lowest level since September 2013, from around $1.3246 late in New York on Friday.

In contrast, in her speech at Jackson Hole, US Federal Reserve Chair Janet Yellen gave a nod to the concerns of some Fed officials about the sustained level of monetary policy stimulus, even as she stressed the need to move cautiously on raising rates.

In a second aspect to his speech in the US, Mario Draghi urged European governments to act more closely on budgetary issues in order to have a coordinated policy across the euro area.

That could mean Germany agreeing to more open-handed financial policies that drive up economic demand, timed to coincide with budget trimming in weaker economies such as Ireland.

Mr Draghi also said that tax cuts can be used to help drive demand in the economy, in what is seen as a shift away from the policy of strict austerity.

Irish Independent

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