03 May 2016

ECB: Government bond markets in a changing environment

Policy interventions are undoubtedly having an impact on market functioning today. The key question, however, is what is the sign and magnitude of those impacts, and whether the trade-offs they present are worth it.

In the case of the European Central Bank’s (ECB) monetary policy, ECB’s ongoing monitoring so far does not suggest impairments to the price discovery process. But even more importantly, ECB’s measures are essential to restore a more robust economic environment where inflation is in line with ECB’s mandate. That environment is the most important variable for dealers and investors and therefore for market functioning.

What is more, it is important to remember that not only policy interventions affect market liquidity. For example, high frequency electronic trading has been blamed for various rapid market moves and charges have been brought against some uses of such technology. Though innocuous in certain situations, such technology can also raise barriers to some investors’ access to liquidity, which would narrow the range of trading interests and could exacerbate volatility spikes when no market participant is there to “catch a falling knife”.

So to return to his initial question of how changes in market structure will affect the funding strategies of long-term borrowers, the best answer he provides is that the interests of regulators, issuers and investors are aligned. All want markets to be able to absorb debt without large dislocations and price formation to be orderly and transparent. This requires that ECB continues the direction set in Pittsburgh in 2010.

From regulatory developments to best practices, market structures are progressively changing, evolving to a new market environment that is more constrained but also more resilient. At the same time, more safety is not a substitute but a complement to well-capitalised banks and sound public finances.

Full speech

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