2026-09-02 Wednesday

The BIS's Fernando Restoy argued that the European banking union's resolution framework is less efficient than those of the UK and US, citing procedural complexity from multiple authorities, a multi-layered legal structure, and constraints on mutualised funding. The Single Resolution Fund can only be tapped after shareholders and creditors have absorbed losses of at least 8% of total liabilities and own funds, and its available funds cannot exceed 5% of total liabilities. Moreover, the CMDI facility for funding transfers is only fully available to banks below an asset threshold of €80bn. These constraints, rooted in constitutional limits on the SRB and political reluctance to share costs, undermine the banking union's goals of denationalising bank risk and integrating the banking market. Restoy proposed reforms including a common deposit insurance scheme, but noted that even the CMDI reforms do not fully solve the problem, as a failing bank may still be wound up rather than resolved because more funds are available in liquidation. For investors, the inefficiency means that resolution of a mid-sized cross-border bank could be slower and more uncertain, potentially affecting recovery values and the credibility of the banking union as a backstop.

South Africa's monetary policy transmission runs through financial markets, where the policy rate anchors all other asset pricing via arbitrage against the safe overnight SARB deposit. The 91-day Treasury bill yield of 7.26% sits just above the policy rate of 7%, reflecting the central bank's rate as the floor for the rand yield curve. Recent macro improvements — a new inflation target, fiscal commitment, and reduced issuance — have flattened and lowered the curve, easing financial conditions and supporting cautious rate cuts.

The curve's steepness has compressed dramatically from a record of more than 5% percentage points in 2020 to near 4% by late 2023, and further moderation followed. In late 2023, 30-year rates were close to 13% while short-term rates were around 9%, a spread that has since narrowed as long rates fell to under 9% and short rates to under 7% by early 2026. This steepening was chiefly interpreted as a fiscal- and country-risk story, and its unwinding reflects reduced government bond issuance and improved demand. The JSE All-Share Index has risen nearly 60% from 2023, and the rand has strengthened from near R20 to the dollar in 2023 to closer to 16 ZAR/USD.

For bond investors, the flatter curve and lower long-end yields directly reduce fiscal costs, while the policy rate's anchor role means any shift in the SARB's inflation target or fiscal credibility would reprice the entire curve.

The Reserve Bank of Australia judges its monetary policy stance to be somewhat restrictive, with the cash rate sitting around the top of the range of neutral rate estimates from its own models and those of market economists. This assessment rests on the tightening delivered earlier this year working through financial conditions, including a 5% appreciation of the Australian dollar on a trade-weighted basis since the start of the year. The RBA's view is that the current setting is consistent with gradually bringing inflation back to target while preserving employment gains.

The judgment, however, is clouded by uncertainty. Some measures of financial conditions have eased in recent months, as market expectations of the cash rate path have declined since May. At the same time, the housing market has softened by somewhat more than the recent rate increase would imply, which could make conditions more restrictive than otherwise. Offsetting these forces, resilient global demand driven by AI-related investment and higher offshore yields stemming from large public deficits tend to make Australian financial conditions less restrictive for a given cash rate.

The RBA acknowledges that neutral rate estimates are imprecise and may be slow to capture recent developments, adding to the difficulty of calibrating policy. The speech highlights that AI activity alone means policy rates need to be higher than otherwise, at least in the short run, while rising government deficits have contributed to the rise in global neutral rates, reducing the tightness of Australian conditions. For investors, the implication is that the cash rate may be near its peak, which could anchor Australian government bond yields and influence the AUD, especially if global yields remain elevated due to fiscal and AI-driven demand.

The EU's excessive deficit procedure, opened in January 2026, requires Finland to correct its deep public deficit by end-2028, implying a shift from expansionary fiscal policy. The channel to bond markets runs through the ECB's 10 September decision: if rates stay on hold while Finland's fiscal consolidation begins, the yield curve's front end will be set by Frankfurt, not Helsinki. This was hiding in Rehn's presentation to the government's budget session, a venue rarely covered by market media; the settlement is the ECB's 10 September rate decision and whether Finland's 2027 budget, due in September, starts the EDP correction.

The ECB attributes the 2026 inflation rise almost entirely to adverse energy supply shocks, with headline HICP inflation climbing to 3.2% from 1.5% between January and May. This contrasts with the 2021-22 surge, which combined supply and demand factors. The central bank's gradual response reflects a trade-off between inflation and output, as energy supply shocks account for 2.4% of the increase, while fiscal and monetary stimulus contribute 0.6% and 0.9% respectively. The analysis suggests that policy tightening may be less effective against supply-driven inflation, influencing the ECB's cautious stance.

UK households' net mortgage borrowing fell to £4.3bn in July from 56,100 in June, below the six-month average, while mortgage approvals decreased to £2bn. This cooling in housing demand comes as the effective rate on newly drawn mortgages rose to 4.45%, reflecting higher borrowing costs. Consumer credit borrowing edged up to −£10.1bn, but the broader money measure M4ex contracted, with annual growth slowing to 4.3%. The data suggest that higher rates are dampening housing activity, potentially easing inflationary pressures and influencing the BoE's policy path.

For bond investors, the upward revision to the inflation forecast suggests that the central bank sees persistent price pressures, which could delay further rate cuts and keep real yields elevated, while the reserve build-up reduces near-term external vulnerability.

The Financial Stability Board's letter to G20 finance ministers and central bank governors, published ahead of their Asheville meeting, highlights financial stability risks from the Middle East situation, vulnerabilities in sovereign bond markets, private credit, and rising leverage in equity markets, as well as cyber risks from frontier AI. The letter emphasizes the need to strengthen financial system resilience. This signals that global regulators are increasingly focused on spillovers from geopolitical shocks and AI-driven leverage, which could prompt coordinated policy responses.

Liquidity indicators worsened across the board: the bid-ask spread DI dropped to −25pp, order quantity DI to −33pp, dealing frequency DI to −6pp, and lot size DI to −16pp. Respondents now expect the 10-year JGB yield to average 2.9% in September 2026 and 3% by end-March 2029, up from previous forecasts.

The deterioration in liquidity metrics suggests that the Bank's bond purchase operations face a less liquid market, potentially increasing the cost of its yield curve control policy.

For investors, the key mechanism is that deteriorating liquidity, as measured by wider bid-ask spreads and thinner order books, could lead to higher volatility in JGB prices and make it more expensive for the Bank of Japan to conduct its purchase operations. This, in turn, may put upward pressure on long-term yields, affecting the pricing of government debt and the portfolios of domestic bond holders.