How will central banks react to higher bond yields?

The recent surge in government bond yields – which is spilling over into higher financing costs for households and businesses – is unlikely to deter central banks from raising policy rates further. We expect major central banks will continue to tighten in coming months.

What you will learn:

• The rise in bond yields partly reflects higher market expectations for policy rates, driven by inflation worries and signs that growth – especially business investment – has been more resilient than expected. These same factors also will continue to prompt central banks to hike rates.
• The rise in yields also reflects an increase in term or risk premia, due partly to worries over unsustainable long-term fiscal trends and higher public debt issuance. This rise in premia may dent growth, but it probably won’t make central banks more dovish. That’s because those fiscal worries also are likely to erode the credibility of central banks’ long-term commitment to low inflation.
• High bond yields have prompted some modest direct responses from central banks. But large-scale direct central bank intervention in bond markets is unlikely unless high bond yields cause financial stability problems.

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