ECB Signals Further Tightening... German Long-Short Term Yield Spread Hits Lowest in 31 Years Amid Recession Fears

Christine Lagarde ECB President
"Inflation slowdown pace is slow"... Wage-driven inflation concerns
Germany government bond yield curve at lowest in 31 years

Christine Lagarde, President of the European Central Bank (ECB), has signaled an additional interest rate hike next month. As high-intensity tightening is expected to continue, German government bond investors sold short-term bonds, causing the spread between short- and long-term interest rates to fall to its lowest level in 31 years.

Christine Lagarde, President of the European Central Bank (ECB)
[Photo by Yonhap News]

At the ECB annual policy meeting held in Portugal on the 27th (local time), President Lagarde stated, "The pace of inflation slowdown is slowing, and high prices are persistently maintained," and pledged to keep interest rates at a "sufficiently restrictive" level for the "necessary period."

The market interpreted this as meaning that the ECB is likely to raise rates next month and maintain them at a high level for some time. Fr?d?ric Ducrozet, Head of Macroeconomic Research at Pictet Asset Management, said, "The president's tone is quite hawkish," adding, "The rate hike next month sounds like a done deal. The possibility of stopping rate hikes is low."

President Lagarde warned about wage-driven inflation. Although workers' wages are rising rapidly, she cautioned that high inflation could persist as corporate productivity slows. According to the ECB, wage growth is expected to exceed 14% by 2025. Meanwhile, the Eurozone's consumer price inflation forecast for this month is 5.6%, significantly surpassing the ECB's target of 2%. Lagarde said, "It seems difficult to confidently say that the central bank has reached the peak interest rate in the near future."

As the ECB indicated maintaining its tightening stance, concerns about a recession grew, and the bond market reacted immediately. In the German government bond market, the spread between the 2-year bond yield (3.15%), which is sensitive to monetary policy, and the 10-year bond yield (2.34%) fell to -0.87 percentage points at one point during the day, marking the lowest level in 31 years since 1992. Generally, in the bond market, longer maturities have higher yields. Long-term bonds pay higher returns due to greater uncertainty and risk. However, when economic conditions worsen, short-term yields rise, and an "inverted yield curve" can occur, where long-term yields fall below short-term yields. The market interprets this yield inversion as a signal of an impending recession.

The German short- and long-term yield spread had already inverted at the end of last year. However, as President Lagarde reaffirmed the high-intensity tightening policy on this day, fears of a recession increased, causing the 2-year bond yield to rise and the short- and long-term yield spread to fall to its lowest level in 31 years.

The Eurozone economy has already entered a recession phase. The Eurozone's GDP growth rate in the first quarter of this year decreased by 0.1% compared to the previous quarter, marking two consecutive quarters of negative growth following a -0.1% contraction in the fourth quarter of last year.

Lin Graham Taylor, Chief Interest Rate Strategist at Rabobank, analyzed, "The message from the (bond) market is quite clear," adding, "The market believes that the ECB's decision to maintain high interest rates will significantly slow down the economy."

This content was produced with the assistance of AI translation services.