Euro, German bond yields jump to one-week high as ECB says it has no FX target

LONDON (Reuters) - The euro and German government bond yields jumped to their highest in a week on Thursday after ECB chief Christine Lagarde said the ECB is watching the euro closely but stressed there is no foreign exchange target.

FILE PHOTO: Euro currency bills are pictured at the Croatian National Bank in Zagreb, Croatia, May 21, 2019. REUTERS/Antonio Bronic

The 10% appreciation of the euro since the end of May, to highs unseen since 2018, has caused concern that a strong currency could dent the bloc’s economic recovery and weigh on already weak inflation.

That had led markets in recent sessions to price in a more dovish tone from the ECB and lifted expectations for further stimulus down the line.

Lagarde reiterated that while the bank monitors the currency closely, it does “not target the exchange rate”. She also noted the pressure from a rising euro on the bloc’s inflation, which turned negative in August for the first time since 2016.

“The balanced tone struck by the ECB at today’s meeting was less dovish than many investors may have been expecting,” said Jai Malhi, global market strategist at J.P. Morgan Asset Management.

“Today’s meeting highlights that the fiscal policy and the European Recovery Fund will be the main lever of stimulus in this crisis and that the ECB will likely be the supporting act.”

The euro rose to its highest level in a week at $1.1917 and was last up 0.8%. Germany’s 10-year bond yield also rose to a one-week high at -0.42%.

Graphic: Euro, bond yield react to ECB's Lagarde -

“It’s a bit of a balancing act for the ECB. On the one hand Lagarde is mentioning the euro is a dampening factor on inflation but at same time the ECB didn’t revise down its inflation projections,” said Carsten Brzeski, chief economist, euro zone at ING.

The ECB kept its inflation projection unchanged at 0.3% for this year, but upped its 2021 projection slightly to 1% from 0.8% in June.

“So there is a two-sided message that is being taken by markets as not dovish but owlish, which is just how Lagarde wants to be perceived,” he said.

Brzeski said he still expects the ECB to expand its pandemic emergency bond purchases by the end of the year.

While the euro rose sharply, it remained below the closely-watched $1.20 level that prompted ECB chief economist Philip Lane last week to warn that the exchange rate matters for the bank.

Ten-year yields on Italian bonds, a key beneficiary of ECB stimulus, rose off session lows, but were still unchanged on the day at 1.09% . The risk premium they pay on top of German debt was at 151 bps, lower than recent one-month highs.

“Markets know there is very little that the ECB can actually do to weaken the currency. Rates are almost as low as they can possibly go and the various asset purchase and lending programs are already sizable,” said Seema Shah, chief strategist at Principal Global Investments.

Reporting by Dhara Ranasinghe, Julien Ponthus, Sujata Rao, writing by Yoruk Bahceli; editing by Andrew Heavens