ECB president Mario Draghi
ECB president Mario Draghi

German 10-year bonds are headed for their first monthly decline since August after the European Central Bank chief suggested that officials may have injected enough money into the euro region’s economy to reach their desired inflation rate of just under 2%. It marked a change of tone from November 20, when he sent yields on shorter-dated notes to all-time lows by saying the institution would take any necessary action to lift consumer prices.

The clarity of Draghi’s words has given way to a less transparent picture for investors trying to divine the ECB’s next move. A market rally driven by its bond-buying programme, or quantitative easing, came to an abrupt halt this month after Draghi unveiled a package of measures that suggested to some people he was facing resistance within the central bank for additional stimulus.

“With the last decision it was very clear to me that the hawks took over the steering wheel,” said Elwin de Groot, a senior market economist at Rabobank International in the Dutch city of Utrecht. “That could be the real story for 2016: not only how willing is the ECB to do more but also are they still able to?”

Bund Yields

While Draghi has said the ECB remains ready to respond to changing circumstances, forecasts for the bond market reflect an uncertain outlook. Predictions for the benchmarkGerman 10-year bund yield for next year range from 0.4% to 1.55%. It was 0.6% on Tuesday.

The start of QE in March pushed the average yield on euro-area sovereign debt to a record low of 0.43%, only for it to surge to as high as 1.08% by the middle of June, according to indexes developed by Bank of America Merrill Lynch.

Market turmoil in China and collapsing commodity prices then reignited fears of deflation, boosting demand for the fixed-coupon payments on bonds and pushing the average yield down to 0.57% by December 2. A day later, it jumped to 0.73% as German yields surged the most since 2011 because the ECB confined its latest stimulus efforts to a cut in its deposit rate and an extension of QE by at least six months.

Policy Driven

Even after that setback, euro-area government have eked out a 2% return this year through December 28, adding to a gain of 13% in 2014. They outperformed US peers, which made 1.1% as the Federal Reserve raised interest rates for the first time since 2006 and signaled more to come in 2016.

“This so-called policy divergence will be the topic of the next year,” said Marius Daheim, a senior rates strategist at Swedish bank SEB AB in Frankfurt. “The markets will continue to be policy driven.”

He recommended investors favour the euro region’s higher-yielding bonds, including those of Italy and Spain, for positive returns.

“The pressure will be on the ECB to do something,” said Kit Juckes, a London-based global strategist at Societe Generale SA. For Draghi, “it’s more a question of adjustments to the tiller to keep the boat sailing in this direction but not get buffeted by other events. He’s reactive.”

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