The ECB only wants to tolerate well-founded increases in yields

The ECB does not see the risk of inflation. Favorable financing conditions for states, companies and private households remain their goal.

The European Central Bank in Frankfurt am Main

IIn recent years, central banks have increasingly named “favorable financing conditions” for states, companies and private households as an intermediate goal of their monetary policy, which should contribute to achieving their inflation targets and solid economic growth. But what is meant by “favorable financing conditions”? After ECB President Christine Lagarde had left invincible well-meaning observers on the financial markets with the vague statement that it was a “holistic and versatile” concept, perplexed, board member Isabel Schnabel recently attempted to light up at a digital conference to bring into the dark.

Two essential characteristics differentiated a monetary policy aimed at securing favorable financing conditions from the previous monetary policy, said Schnabel. “The first characteristic is a move away from a policy that tries to keep lowering interest rates.” Schnabel admits with remarkable openness that a further reduction in the already historically low key interest rates will not only have hardly any positive effects on inflation and economic growth It also names the risks arising from very low key interest rates, such as the dangers to the stability of the financial markets resulting from high asset prices.

As a second characteristic of a monetary policy aimed at securing favorable financing conditions, Schnabel mentioned the flexible use of the instrument of bond purchases, the volume of which should in future be more closely related to the development of the bond yields. Schnabel, however, made it clear that, unlike the Bank of Japan, for example, the ECB is not thinking of precisely controlling the nominal government bond yields that can be observed on the capital market. The Japanese concept is known among experts as “controlling the yield curve”, and quite a few financial market participants would like to see the ECB and the American Federal Reserve also commit to this idea.

“It’s not about cementing a certain interest rate level in monetary policy”

However, this is not to be expected. On the one hand, according to Schnabel, the ECB is less interested in the nominal returns observable on the market and more in the real bond yields adjusted for expected inflation. This is because the investment decisions of companies and the spending decisions of private households are based more on the expected real than the nominal interest rate. In the course of an economic recovery and rising inflation expectations, according to Schnabel, the ECB could therefore tolerate a rise in nominal bond yields.

Bundesbank President Jens Weidmann also emphasized this connection in a speech. “If, for example, nominal interest rates rise because inflation expectations are approaching the inflation rate we are aiming for, then that would be a welcome development. Because it would be a sign that our monetary policy measures are working, ”explained Weidmann. Other economic fundamentals could also improve and help real returns rise.

“In isolation, this could be seen as a deterioration in financing conditions. The holistic perspective would make it clear, however, that this is only a side effect that does not destroy the better economic outlook, ”said Weidmann. “In my opinion, financing conditions should be able to develop in line with the economic recovery in the euro area. So it is precisely not a question of cementing a certain interest rate level in monetary policy. Rather, a premature deterioration should be prevented in order to counteract the downward pressure of the pandemic on medium-term price developments. “