De Cos points to the US bond market as the best reason for the ECB’s pause

The European Central Bank (ECB) should decree next week its first pause in more than a year in interest rate increases and a powerful reason for this is what is happening on the other side of the Atlantic. This is the opinion of the governor of the Bank of Spain and member of the Governing Council of the ECB, Pablo Hernández de Cos.

In an interview published this Monday by the Financial TimesDe Cos insists in his message sent in recent weeks that the ECB should maintain this level of rates for a while (The main refinancing rate is already at 4.5%, a 2001 high) and not proceed with further increases. The novelty on this occasion is that it has pointed out the US Treasury bond market as a powerful reason for the Eurobank not to move the crank on upward rates again.

“The recent rise in long-term interest rates is not related to domestic factors, such as changes in market expectations for euro zone inflation,” De Cos said, referring to increases in borrowing costs. of governments. “Rather, it has been driven by the dynamics of the US market.

The recent dizzying rise in US sovereign bond yields, with the 10-year note (T-Note) flirting with the 5% and registering levels not seen since 2007, it has been noticed throughout the world, including the Eurozone. According to De Cos, the fall in the US public debt market has caused an increase in the cost of credit on the other side of the Atlantic.

“The recent instability in the US bond market is attributed to concerns about increasing supply and decreasing demand for Treasury bonds. This is largely due to the forecast that the ratio between federal debt and the US GDP will exceed 100% in 2025. This increase in federal debt will result in a growing deficit that will have to be financed through Treasury bond issues. However, there are concerns whether hitherto price-insensitive buyers will end up also by withdrawing from the market, which could cause an increase in the cost of issuing dollars with interest and a credibility problem in the US government,” explains Javier Molina, eToro analyst.

The governor of the Bank of Spain believes that this increase seen in European sovereign bond yields will strengthen last month’s assessment by the ECB that “maintaining the current level of rates for a sufficiently long period will be broadly consistent” with the objective of 2% inflation “in the medium term”. It should be remembered that De Cos is one of the members dovish (supporters of a less restrictive monetary policy) within the ECB.

Since the ECB meeting last September, bond markets have sold off sharply, sending 10-year bond yields in many eurozone countries to their highest level in more than a decade, despite a partial recovery in the last week.

“We have a additional hardening of financial conditions,” De Cos insisted, adding that the eurozone economy was already stagnant and that the war between Israel and Hamas “certainly will not help boost confidence, consumption or investment.” “Our September assessment that the level of interest rates was now appropriate is even more valid today,” he emphasized.

In the latest survey of economists from Bloombergthe consensus is that the ECB will not proceed with the cuts of types until September 2024, suggesting that the message from authorities that cuts will not come soon is getting through. This survey differs from the immediately previous one, in which a first cut was contemplated for March 2024.

Also in view of the ECB meeting next October 26th and the possibility that it discusses some possible acceleration of the withdrawal of the sovereign bond purchase program due to the pandemic (PEPP), De Cos has called for “caution.”

Fiscal consolidation in 2024

Asked about the concern that higher borrowing costs will seriously impact countries with high levels of debt, with the case of Italy once again in focus, De Cos underlined the need for governments to begin reducing deficits next year. “Fiscal consolidation should begin in 2024,” he said.

In the internal case of Spainwith a debt of 113% of gross domestic product (GDP)the fourth highest among eurozone countries, De Cos has highlighted the need for the future government to build a cross-party agreement around a plan to reduce the deficit, boost the country’s growth potential and reduce unemployment, which has fallen drastically, but is still the highest in the EU.

“For these structural reforms and the fiscal consolidation process to be successful, the policy measures must be permanent,” he stated, noting that it is “essential that the design, approval and implementation of these measures are supported by a strong consensus policy”.

Finally, while the governor of the Bank of Spain gives a gloomy assessment of eurozone growth, he has given several reasons why the Spanish economy will perform better: The central bank expects an expansion of 2.3% this year and close to 2% in the next two years. That compares with the ECB’s forecasts for eurozone growth of 0.7% this year, 1% next year and 1.5% in 2025.

On paper, De Cos explained, higher rates would affect the Spanish economy more quickly, because around 70% of the country’s mortgages are at variable rates and not fixed rates. But this has been offset by Spain’s lower dependence on a manufacturing sector in difficulties and by the greater boost in tourism. Likewise, he added, Spanish household spending has also been boosted by a faster fall in inflation than in other eurozone countries and by falling unemployment. A “key difference” with the rest of the region, he added, is that relatively low wage increases would make Spanish exports more competitive.