The announced reduction of quantitative easing in the USA and its effect on yield curves

The May FOMC meeting and a number of statements made by leading representatives of the US central bank led to widespread speculation that the Fed would moderate the pace of its bond purchases soon. This resulted in a surge in bond yields globally, while stock markets declined and the currencies of emerging economies weakened. In particular, long-term interest rate outlooks were revised, but a correction occurred in late June and bond yields edged down again. In addition, some Fed representatives quelled the speculation by stating that the retreat from quantitative easing depended on the US growth outlook. Nevertheless, the implied outlook for EURIBOR and LIBOR rates remains above the path expected by the markets in May, with the shift being particularly visible for dollar LIBOR rates (see Chart 1). The correction was more pronounced in the euro area, primarily as a result of the ECB’s communication following the June meeting. The ECB announced that monetary policy would remain accommodative for as long as necessary and key interest rates would remain at present or lower levels for an extended period of time (“forward guidance”). On the Czech financial market, these factors were also reflected mainly in medium-term and long-term rates, whereas the short-term rate outlook increased only slightly.

Chart 1 (BOX)  EURIBOR and LIBOR rates – history and outlook
The market interest rate outlook shifted upwards after the Fed announced it would limit quantitative easing
(percentages; monthly averages; source: Datastream, outlook based on market contracts)

Market rates in the euro area are also affected by the ECB’s long-term operations. The volume of three-year lending operations and therefore also excess liquidity has been falling steadily since January 2013 (see Chart 2). The faster decrease in excess liquidity in 2013 Q1 was due to banks’ efforts to repay long-term loans ahead of schedule, motivated mainly by a lower need for liquidity buffers and better funding opportunities on the market. The decrease slowed in the following months. Excess liquidity stood at EUR 275 billion in the first week of July.

Chart 2 (BOX)  Excess liquidity in the euro area
Excess liquidity fell sharply in 2013 Q1, but the rate of decline should slow over the remainder of this year 
(EUR billions; weekly data; source: Datastram, outlook based on EONIA forwards)

In June 2013 the market was still expecting excess liquidity to fall below EUR 200 billion by the end of this year, but in July the outlook shifted slightly upwards. This was mainly caused by ECB communications stating that monetary policy would remain accommodative for an extended period of time. By the ECB’s estimation, market rates will stay only slightly above its deposit rate if excess liquidity is between EUR 100 and 200 billion.