Policy brief

Is the recent increase in long-term interest rates a threat to euro-area recovery?

After reaching historically low levels, European long-term sovereign yields experienced a notable rise at the end of 2016 and beginning of 2017. This

Publishing date
29 May 2017

This policy contribution was prepared for the Committee on Economic and Monetary Affairs of the European Parliament (ECON) as an input for the Monetary Dialogue of 29 May 2017 between ECON and the President of the ECB. (http://www.europarl. europa.eu/committees/ en/econ/monetarydialogue.html). Copyright remains with the European Parliament at all times.

After reaching historically low levels in the first half of 2016, European long-term sovereign yields experienced a notable increase in the second half of 2016 and at the beginning of 2017, before stabilising in the last few months.

The nominal long-term interest rate can be decomposed into the following components: a risk-free rate, various premia to compensate investors for future inflation and potential defaults, and a term premium.

All of these components have been on a downward trend over the last few years. But some of these trends might have reversed in the second half of 2016, leading to an increase in long-term yields.

Understanding the main factors driving interest rates higher in recent months is important. If the rise in interest rates is driven by good news for the economic outlook for the euro area, it would represent a welcome normalisation of the European situation. However, if higher rates are unjustified by economic fundamentals (ie higher growth and inflation expectations), it would represent an unwarranted tightening of financial conditions that could jeopardise the recovery.

In fact, the recent movement in sovereign yields in the euro area has resulted from the combination of several factors: 1) a rise in country-specific risks arising mainly from political uncertainty in some euro-area countries; 2) a revision of market expectations for inflation, growth and the path of future interest rates because of good news about the recovery in the euro area; 3) spill-overs from increasing yields in the US coming from the normalisation of monetary policy by the Fed and a potential fiscal policy shift by the new administration; and 4) an increase in the term premium reflecting uncertainty around markets’ expectations.

The recent rise is thus mainly driven by good news and does not represent a strong tightening of financial conditions for euro-area households and companies, nor does it currently endanger public finances. Moreover, from an historical perspective (especially when compared to the significant decline in yields over recent decades), the recent rise is of a relatively moderate magnitude and very much similar to previous benign episodes of yield increases (such as in early 2015). The ECB should monitor the situation carefully but it should not be a major concern for the moment.

Nevertheless, if in the future sovereign yields from euro-area member states drift away from levels compatible with economic fundamentals, or threaten the European recovery and the return of inflation towards 2 percent (which is not the case at the moment) the EuropeanCentral Bank’s expanded toolbox should be sufficient to influence the yield curve.

About the authors

  • Grégory Claeys

    Grégory Claeys, a French and Spanish citizen, joined Bruegel as a research fellow in February 2014, before being appointed senior fellow in April 2020.

    Grégory Claeys is currently on leave for public service, serving as Director of the Economics Department of France Stratégie, the think tank and policy planning institution of the French government, since November 2023.

    Grégory’s research interests include international macroeconomics and finance, central banking and European governance. From 2006 to 2009 Grégory worked as a macroeconomist in the Economic Research Department of the French bank Crédit Agricole. Prior to joining Bruegel he also conducted research in several capacities, including as a visiting researcher in the Financial Research Department of the Central Bank of Chile in Santiago, and in the Economic Department of the French Embassy in Chicago. Grégory is also an Associate Professor at the Conservatoire National des Arts et Métiers in Paris where he is teaching macroeconomics in the Master of Finance. He previously taught undergraduate macroeconomics at Sciences Po in Paris.

    He holds a PhD in Economics from the European University Institute (Florence), an MSc in economics from Paris X University and an MSc in management from HEC (Paris).

    Grégory is fluent in English, French and Spanish.

     

  • Konstantinos Efstathiou

    Konstantinos, a Greek citizen, works in Bruegel as an Affiliate Fellow in the Macroeconomics and Governance area. Before joining Bruegel, Konstantinos was at the European Commission, as a Blue Book Trainee in the Cabinet of President Juncker. He also interned at the Central Bank of Luxembourg (BCL) as a research assistant, involved in projects related to the Wage Dynamics Network (WDN) research group.

    He holds a Master in International Economics and International Relations from the Johns Hopkins University School of Advanced International Studies (SAIS), where he specialized in Quantitative Methods and European Studies.

    Konstantinos’ research interests include macroeconomics, European economic governance and international economics.

    Konstantinos is a native speaker of Greek, speaks fluent English and has good knowledge of French.

    Declaration of interests 2017

    Declaration of interests 2018

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