Italian yields rise to seven-week high as ECB brings PEPP into focus

AMSTERDAM/LONDON: Italian 10-year bond yields jumped to seven-week highs on Thursday, a move analysts attributed largely to the European Central Bank's saying in its policy decision that it may not use the firepower of its pandemic bond purchases in full.

At its policy meeting, the ECB kept its deposit rate unchanged at -0.5% and maintained the overall quota for bond purchases under the Pandemic Emergency Purchase Programme (PEPP) at 1.85 trillion euros, as expected.

But in its policy decision, "if favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full," the ECB said.

The ECB has made similar statements before, but including the phrase in the policy decision text brought it into focus.

"When there are small changes, markets tend to focus on them. And while there was nothing new in the wording... the fact that it was lifted to the statement from the opening remarks in December was mostly likely because the hawks wanted it there," said Andreas Steno Larsen, global chief FX and rates strategist at Nordea.

"So it carries a bit of significance even if it is a minor detail."

Italian bond yields -- among the biggest beneficiaries of ECB bond buying -- jumped 6 basis points to their highest since December 2. German bond yields also rose, with the 10-year benchmark yield touching an eight-day high at -0.487%.

Expectations that the ECB will purchase more than the net issuance from euro zone governments have kept borrowing costs for countries such as Italy at or near record lows, even as the they take on record-high levels of debt to tackle the pandemic.

"Where it matters for the market is that prior assumptions of the ECB swallowing all of net supply in EU in 2021 - that is now dependent on the state of the economy," said Rishi Mishra, interest rates strategist at Futures First Info Services.

Bond yields initially came off session highs as Lagarde emphasized that while PEPP may not be used in full, it may equally be re-calibrated, but rose again after the press conference.

While the ECB broadly kept to its economic forecasts from December, Lagarde also said that risks to the economy remained tilted to the downside but were "less pronounced", which may have also helped push bond yields higher.

The euro rose as much as 0.5% on the day following the decision, with the ECB reiterating that it closely monitors the euro exchange rate.

Euro zone stocks reduced gains after Lagarde's comments on the economic outlook, reaching a session low. They were last flat on the day.

Given delays in vaccination programmes and variants that have made the coronavirus more infectious, the ECB "remains very likely to spend the full envelope allocated to the PEPP as well as ease policy further via other tools in the coming months," said Fidelity International's global economist, Anna Stupnytska.