EUR/USD recovers some ground after ECB decision

The Euro (EUR) staged a recovery against the US Dollar (USD) on Thursday, paring back some of its initial losses to reach the 1.0520 region. This resurgence came in the wake of the European Central Bank’s (ECB) unexpected decision to maintain its rates and continue flexible reinvestments, soothing concerns within Southern European markets.

Eurozone borrowing costs saw a decline, and the yield spreads between core and peripheral government bonds tightened after the ECB broke a streak of 10 consecutive rate hikes. The central bank confirmed its commitment to the flexible reinvestment of part of its extensive bond portfolio until 2024, a move that provided assurance in the markets.

The ECB’s decision to continue reinvestments from the Pandemic Emergency Purchase Programme (PEPP) until December 2024 played a significant role in bolstering investor confidence. Expectations that the deadline for PEPP reinvestments might be brought forward had previously led to concerns, particularly impacting bonds of Southern Europe’s most indebted nations.

ECB President Christine Lagarde highlighted the importance of PEPP reinvestments as the first line of defence against fragmentation. This fragmentation refers to an excessive yield spread widening between core and peripheral bonds, potentially impeding the smooth transmission of monetary policy across the euro area.

Italy’s 10-year government bond yield saw a drop of 6.5 basis points to 4.85% after the ECB statement, down from 4.92%. The spread between Italian and German 10-year yields, a crucial measure of the premium investors demand to hold debt from the euro area’s most indebted countries, tightened to 198 basis points, reflecting increased market confidence.

Market sentiment was further influenced by recent developments, including a surprising downturn in euro zone business activity and a near standstill in bank lending. Germany’s 10-year bond yield, which serves as the bloc’s benchmark, decreased by 3 basis points to 2.85% after the ECB statement, down from 2.87%, indicating a positive response from investors to the ECB’s decision.