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The various non-standard measures that have been introduced by the ECB to support monetary policy transmission in certain market segments will stay in place as long as necessary, and there are other measures, standard and non-standard, that we can deploy if warranted. Therefore, at the current juncture, there should be no doubts that our “exit” is distant and our monetary policy is and will remain accommodative.
Let me start with some recent developments in European bond markets. Since early 2012, we have seen pronounced shifts towards bond holdings in investment funds and a general decline in yields across all risk categories. Equity holdings of euro area investment funds slightly declined compared with 2011, whereas net flows into fixed income funds increased substantially.
As in the US, the search for yields in corporate bond markets in the euro area has intensified in recent months: corporate bond spreads are at historical lows. Chart 2 compares the historical evolution of yields on high-yield bonds with default probabilities. Yields are generally back to pre-crisis levels, but default probabilities are still significantly higher. One noticeable exception is provided by German corporate bonds, which have reverted to low default probabilities. The decline in yields of high-yield bonds is even more remarkable as the supply of those bonds has been shooting up recently. Total issuance of euro area non-financial corporate debt in 2012 was 60 per cent higher than issuance in 2011, and it remained strong in the first months of this year. The share of high-yield debt in total issuance rose from one-quarter in 2012 to one-third in the first quarter of 2013, above the average recorded from 2006 to 2012.
Overall the evidence for the euro area on corporate bonds parallels the one for the US and the two markets appear closely linked to each other. As I have discussed before, an abrupt unwinding of these searches-for-yield – perhaps triggered by highly leveraged investors rushing for the exit – would be a source of concern for financial stability. However, the extent of the risk also depends on the degree of maturity transformation and the stability of funding.
Euro area government bond markets have appeared resilient recently. The dispersion of yields was low in the first quarter of 2013, and volatility remained close to its 2009 (pre-sovereign debt crisis) levels. Pivotal developments in reversing the deteriorating trend in confidence included the ECB’s announcements on the Outright Monetary Transaction (OMT) programme and European leaders’ commitment to establishing a banking union, along with noteworthy national developments, including the recapitalisation and restructuring of the Spanish banking sector.
These are all positive developments, but there is certainly no room for complacency. Progress towards a genuine Economic and Monetary Union should be confirmed along the lines of President Van Rompuy’s report, starting with clear and predictable rules for bank resolution and with the establishment of a single resolution mechanism, complementing the single supervisory mechanism as the second pillar of the banking union.
The continuation of the current low level of government bond spreads cannot be taken for granted, and countries efforts towards sustainable fiscal positions should thus continue unabated. A sudden re-pricing of risks may lead to an increase in spreads, despite the on-going fiscal consolidation efforts, and even more so in countries where consolidation has been delayed. This would put renewed pressures on governments and revive the fragmentation of euro area bond markets. One possible strategy to mitigate this risk is to increase the average maturity structure of the debt, but the best remedy is to cut on the quantity of risk by swiftly improving government solvency.
Let me turn to the final part of my presentation and look at some quantitative assessments of the various risks related to the current low-interest-rate environment. These assessments are based on the regular forward-looking solvency analyses conducted at the ECB. I would like to discuss the results for four scenarios including a current baseline scenario. The three alternative scenarios are related to a possible return of risk aversion and a rise in interest rates in various market segments:
The details of these scenarios and the underlying methodologies are discussed in detail in the latest ECB Financial Stability Review from May 2013. Just let me say that they are designed to account for a number of transmission channels and the size of the shock is based on historical evidence.
The scenarios generate a rich set of results, but let me focus on the implications for bank capital. Under the baseline scenario, the core Tier 1 capitalisation of euro area large and complex banking groups would increase from 11.2 per cent in the fourth quarter of 2012 to 11.3 per cent by the end of 2014.
Certainly, with regard to the findings of the adverse scenarios, they crucially depend on the implementation details of the individual scenarios. Nevertheless, we observe that a scenario configuration involving a rise in interest rates and asset price declines would in general tend to exert a negative influence on banks’ solvency positions.