Wood: To a higher level will the ECB ‘tolerate’ the Greek bond yield to move – Greece shielded but also vulnerable

Her Eleftherias Kourtali

The ECB held an extraordinary meeting and reiterated its commitment to combating fragmentation, using the flexibility of PEPP reinvestments and reaffirming that the committees would accelerate the completion of the design for the anti-fragmentation tool.

According to Wood, the key question now is what is the tolerable limit for the ECB on 10-year government bond yields in eurozone countries, and especially the periphery, which can be a balance between the challenges of inflation, a tolerable level of interest rates. which does not jeopardize public debt and allows the private sector to continue investing in the green and digital transition.

Wood believes the range is 3% -5%: the lower limit is for core countries and countries with high credit ratings, and the upper limit is for countries with high debt, such as Greece. This range reflects Wood’s basic view that inflation in the euro area will be higher this decade, at 4% on average, with the risks of a higher level existing if the stated policy objectives are not achieved effectively

In order to stabilize markets in the Eurozone, Wood believes that two components are needed, which he considers feasible: first, the ECB must announce in detail its strategy for anti-fragmentation tools, and second, the countries that are most vulnerable to challenges. funding, as QE is over, some form of differentiation will be needed.

Referring to Greece, Wood points out that its financial position is shielded by the financial results of rescue and surveillance programs and the favorable results of reform efforts in recent years. However, it is vulnerable to the transmission of a crisis in the bond market due to the limited size of Greek bonds in circulation and, therefore, is disproportionately affected at present. Wood expects long-term Greek bonds to trade closer to Italian ones in a few months, as the ECB clarifies its strategy and markets gain confidence in Greece’s outperforming Italy in terms of its current growth potential.

Wood believes that the best result is for the ECB to effectively “enforce” with its policy and strategy a range of 10-year government bond yields in the euro area at 3% -5% in the medium term (up to 36 months) for the following reasons:

– It is a range that is compatible with the marks of the fair value models, which in turn reflect both the ECB’s QE performance and Wood’s view of inflation.

– For the higher range, Italy has an average debt debt ratio of seven years, which gives it some flexibility in how quickly interest rates affect debt sustainability. According to Wood, a nominal interest rate of 4% -5%, although higher than in recent years, is consistent with a sustainable interest rate, given the low but improving potential growth and Italy’s average inflation in the future . Exceeding 5% would be, objectively, really difficult for the country to manage and “communicate” in the markets as a viable interest rate, and would also be a significant increase in borrowing costs, which would halt the recovery in investment. Wood believes that the yields of the 10th bonds of the rest of the region, such as Greece, should move to similar levels.

– The lower limit for the other countries that are fiscally stronger, ie 3% -4% is explained by the fact that Wood expects the yields on 10-year German bonds to reach 2% in the near future, but it sees this, increasingly, as a percentage that does not seem viable in the medium term, because inflation is high and widespread in Germany, and also due to the impact of the growing EU common issue.

“We want to emphasize that the 3% -5% range is the maximum tolerable in the near future, for us, up to 36 months. We consider it reasonable that the ECB will not be really enthusiastic to reach this range immediately, so we could “to have a transition period of three to four quarters with a lower range, 2% -4%, in which we are already,” notes Wood.

He also stressed that there was no reason to continue to estimate that German bond yields would be traded so low, given that the inflation challenges for Germany are in fact worse than those facing the region.

In addition, he says, over time, the EU will issue more common debt to fund the Recovery Fund and possible extensions to facilitate the green transition, which will create an alternative, comparable and more liquid bond that will allow increase in German bond yield.