European Bond Yields Dive on QE

The eurozone economy remained weak last year, growing by just 0.9%. Nonetheless, this did represent an improvement compared to the 0.4% and 0.8% declines in GDP recorded in 2013 and 2012 respectively, writes Oliver Mangan, Chief Economist at AIB.

Germany remained the key driver of growth in 2014, with the economy expanding by 1.6%.

Meanwhile, the underperformance of France (+0.4%) and Italy (-0.4%) continued to weigh on eurozone growth, as they account for roughly 37% of its GDP.

The data for the first quarter of 2015 have been generally more upbeat, showing tentative signs that the long-awaited pick-up in growth may now be in the offing.

For example, the key composite PMI averaged 53.3 points, above the fourthquarter average of 51.5. This is consistent with quarterly GDP growth of about 0.4%.

The EC economic sentiment index averaged 102.6 in quarter one, up from 100.9 in the previous quarter. The improving picture is backed up by key national surveys of activity, such as the German IFO, French INSEE, and Italian ISTAT indices, which are all on a rising trend.

‘Hard’ data measures of economic performance are also showing indications of improvement. Retail sales were up by 0.8% in the January/February compared to the final quarter of last year. German retail sales have been especially strong.

In the meantime, industrial production rose by 0.7% in the first two months of 2015, over the fourth quarter of last year.

A feature of the better output performance has been a recovery in the energy sector, declines in which had acted as a drag on growth throughout much of 2014.

The labour market is also improving. Employment was up by 0.8%, year-on-year, in the second half of last year.

Encouragingly, the employment component of the composite PMI moved further above the job growth-indicating 50-point level in the opening quarter of 2015, averaging 51.5. This suggests that the pace of growth in employment is picking up.

Meanwhile, the unemployment rate fell to 11.3% in February. This is its lowest level since May 2012. However, it still represents a very high jobless rate — both by historical standards and compared to other major economies.

Monetary aggregates have also seen more encouraging trends recently. Growth in M3 money supply picked up to 4% year-on-year in February, its fastest pace since April 2009.

Growth in underlying loans to the private sector has also improved, rising to 0.6% year-on-year, its best level since March 2012.

The eurozone recovery, though, still faces some significant headwinds.

Weak credit growth, tight fiscal policy, high unemployment and a lack of structural reforms in some economies continue to act as restraints on the pace of activity.

However, there are also some tailwinds for the economy too, including the favourable impact of lower oil prices, a weaker euro and the impact of recent monetary policy easing measures, which have resulted in super-low interest rates.

These positive developments have resulted in the ECB staff growth forecasts being revised upwards.

The ECB is now forecasting growth of 1.5% this year (previously 1%) and 1.9% in 2016 (from 1.5%) and 2.1% in 2017. Last week, the IMF also raised its growth forecast for eurozone GDP to 1.5% for 2015.

There has been some speculation that the pick-up in economic activity might see the ECB scale back, or taper, its quantitative easing (QE) programme at some stage.

However, ECB president Mario Draghi indicated last week that he was surprised at the speculation about an early exit from the QE programme. He said that the ECB intends to implement the QE programme in full. It is intended to run until at least September 2016. It looks like full steam ahead with QE, then.

This is keeping downward pressure on eurozone bond yields. German 10-year yields have fallen below 0.1%, with Irish 10-year yields at 0.7%, record low levels.

Source: Irish Examiner April 14th 2015

Pictured above is President of the European Central Bank, Mario Draghi.