Butterfly effect

Europe has unconditional bond-buyer at last: Japan

The Bank of Japan's money printing machine is forcing down risky government bond yields 6,000 miles away. The hope of Japanese money is helping Euro zone bond markets shake off a swathe of bad news. European governments shouldn't take gentle markets for granted.

The European Central Bank's promise last year to buy government bonds is still untested. This is partly because the mere threat helped relieve the pressure on cash-strapped governments, and partly because countries like Spain fear the stigma of having to ask for help - especially if it comes with ECB demands of further reforms.

European bond markets now seem to think there is a new, unconditional buyer in town. Yields have fallen sharply since the Bank of Japan promised to double its balance sheet earlier this month. The scenario is that a weakened yen would lead Japanese investors to load up on foreign assets. And even if they stick to high quality, or so-called "core" bonds, that could trickle down to peripheral debt as well. That hope has already had a real impact, in spite of renewed problems in many European countries. French 10-year yields hit record lows this week even as the Hollande government is paralysed by scandals. Spanish 10-year yields reached their lowest point since 2010, despite the government's inability to reach its fiscal targets. And Italian yields have shrugged off any fallout from the country's botched election in February, even if the country is still without a government.

At the moment, hope is all it is. Investors are front-running what they think will be a wave of money. Rumours of large Japanese purchases abound. Recent data is less encouraging: Japanese investors actually reduced their holdings of foreign debt last week.

Even if the trend is confirmed, it would be a mixed blessing. True, falling yields in the periphery will smooth the Euro zone's broken monetary transmission mechanism, whereby Spanish and Italian economies and companies struggle with high borrowing costs. But the main beneficiaries remain the zone's stronger countries that may exacerbate existing tensions if they keep borrowing on better terms. Lastly, governments may see it as an excuse to delay necessary reforms - precisely what Mario Draghi's bond-buying plan was designed to avoid. Policymakers don't need a false sense of security that can only prompt them to make more mistakes.