Posted October 12, 2014 Ilja Isakow
Currently we are experiencing record low yields on the German 10 year Bund; in fact investors are currently gaining a real negative return when taking inflation into account. But what are the key drivers behind this ultra low yield environment?
While country financiers are celebrating this low borrowing cost, the reasons behind it are gloomy. Initially we had observed a rally within bonds based on the ECB's strong commitment to embark upon a large scale purchase of euro zone government bonds. However the current economic data coming out of Europe and the lacking inflation across the zone is pushing investors to believe that perhaps Europe is approaching a 'lost decade' as was observed in Japan.
Although the ECB took action by cutting rates in June and furthermore Mario Draghi's strong stance at the Jackson Hole summit ensuring investors all needed actions would be taken to ensure price stability, the downward pressure on inflation remains. Even if the ECB does opt to do a full blown quantitative easing programme, its direct impact on inflation has been doubted by critics.
Furthermore Germany's strong opposition to the ECB's current actions are not helping. Although the historic German fear of inflation has influenced this opposition, many critics have also argued that not only does further action in form of purchasing "junk bonds" by the ECB go beyond its current mandate to maintain price stability, but in addition creates a significant risk on the ECB's balance sheet. A risk which is ultimately carried by the tax payer.
Although it remains to be seen as to what action the ECB shall take in order to combat this low inflationary environment, Germany's strong opposition is yet to be subdued.