The investment programme would be targeted at infrastructure and defence. The amounts suggested exceed €500bn. It should also be noted that the president of the European Commission, Ursula von der Leyen, has announced the . Deregulation measures are also under discussion. The rise in bond yields in Germany can be explained in two ways: on the one hand, by the expected increase in new issues; on the other, by higher economic growth potential in the medium term, implying a rise in the real interest rate.

Let’s look at this more closely. An increase in issuance implies an increase in the supply of bonds. With unchanged demand, this should lead to lower bond prices and higher yields. It can also be argued that at constant demand, a higher yield will be needed to absorb the additional supply of bonds. As with all supply and demand logic, the key question is the elasticity of demand.

In fact, an increase in supply can lead to a new equilibrium without causing a sharp fall in prices. This would result in a small increase in yields, particularly if there is significant latent demand and a small increase in bond yields is enough to attract many investors. As savings in the eurozone are very high, institutional investors, such as insurance and pension funds, have risk management constraints that support demand for high-quality bonds.

Let’s now look at the long-term determinants of bond yields. The bond yield can be decomposed to separate the return linked to expected inflation and the return in real terms (or “purchasing power”) linked to economic growth. At this stage, long-term inflation expectations measured on the basis of inflation-linked bonds have risen slightly but remain fairly stable at around 2%. This is not surprising, as the European economy is not at full employment and an acceleration in growth will not necessarily generate inflation above the European Central Bank’s target. The recent rise in bond yields can therefore be explained primarily by a rise in yields in real terms. The German real yield rose by 22 basis points to 0.76%.

In fact, the German government’s economic stimulus announcements (especially those related to infrastructure) and the potential for deregulation at European level suggest higher potential growth in real terms. This is the maximum growth compatible with stable inflation. While this was estimated to be close to zero, we believe it will be closer to 1% if the measures mentioned above are implemented.

We see no reason to doubt the ECB’s ability to keep inflation close to 2% over the next few years. In view of higher growth potential, it is therefore likely that the yield on the 10-year bond in Germany will stabilise in a range between 2.50 and 3% over the next few months.

This scenario is also based on the idea that demand for very high quality bonds is highly sensitive to even a moderate rise in the yield. A rise above 3% is possible but should be temporary given our analysis.

Guy Ertz is chief investment advisor at BGL BNP Paribas and deputy global CIO at BNP Paribas.

This article was originally published in .