Fundamentals versus market sentiments in the euro bond markets: Implications for QE

Abstract

Despite the partial realignment of European long-term government bonds after the crisis in 2012, there has been some renewed divergence in yields in the last years. We analyse the sources of these divergences and find that the government bond markets in the Eurozone are highly sensitive to changing market sentiments, both in time and across countries. We analyse the implications of this finding for the QE-programme. Our analysis of the recent developments in the bond markets and in the macroeconomic developments of the euro area suggests that pulling the plug on QE too soon might undo some of the benefits of QE in the countries of the periphery and may lead to increases in the refinancing costs of member states with little or no fiscal space.