The European Central Bank published a keynote speech by Executive Board member Isabel Schnabel arguing that markets’ repricing towards higher long-run real interest rates is consistent with an upward shift in the natural rate of interest (r*), reflecting both a change in the inflation risk environment and a decline in the convenience yield on safe assets as the global economy moves from a “savings glut” to a “bond glut”. In support, the speech points to a roughly 2.5 percentage point rise in the ten-year German government bond yield since late 2021 that is attributed mainly to higher real rates rather than higher inflation compensation, alongside increases in market-based real forward rates (such as the expected real one-year rate in four years) and higher model-based r* estimates. It links falling convenience yields to increased net supply of government bonds, citing a persistent narrowing of the ten-year Bund-swap spread that turned positive in October for the first time in ten years and a tightening in the KfW-Bund spread from around -80 basis points in October 2022 to around -30 basis points, alongside repo-market convergence across collateral classes. Drivers highlighted include fiscal deficits estimated at around 5% of GDP across advanced economies, declining foreign official demand for US Treasuries, and ongoing central bank balance sheet normalisation. Schnabel draws three policy implications: careful monitoring of when policy ceases to be restrictive as r* rises, recognition that balance sheet policies can shift r* via the convenience-yield channel and may therefore be less effective than assumed, and the need to supply reserves elastically as quantitative tightening reduces excess liquidity. For the euro area, she notes survey and lending indicators suggesting restraint has declined, including banks reporting that the general level of interest rates no longer weighs on corporate credit demand and a net 42% reporting stronger mortgage demand, alongside credit growth of 1.5% to firms and 1.1% to households for house purchases in December. On implementation, the speech references the ECB’s revised operational framework, under which banks can obtain reserves on demand at 15 basis points above the rate paid on deposits at the central bank, and notes that banks can generate on average EUR 0.92 of net high-quality liquid assets per euro borrowed when using non-HQLA collateral in Eurosystem lending operations. It suggests exploring regular operational testing for counterparties, greater mobilisation or pre-positioning of eligible collateral, and possible access to refinancing operations through a centrally cleared infrastructure, with further reflection and a benefits-and-costs assessment still needed.
European Central Bank 2025-02-25
European Central Bank’s Schnabel argues higher natural rate of interest requires caution on rate easing and changes how QE and QT are assessed
ECB Executive Board member Isabel Schnabel's speech argues that the market's shift to higher long-term real interest rates aligns with an upward adjustment in the natural rate of interest (r*), influenced by inflation risk changes and a decline in the convenience yield on safe assets. She notes a 2.5 percentage point rise in the ten-year German bond yield since late 2021, mainly due to higher real rates, and discusses policy implications, including monitoring policy restrictiveness and balance sheet policies' impact on r*. The speech also references the ECB's revised operational framework and suggests exploring operational testing and collateral mobilisation for liquidity management.