Germany's benchmark borrowing costs rose the highest level in a month Tuesday, following a surge in the single currency, after an upbeat assessment on the region's economy from European Central Bank President Mario Draghi.
Benchmark 10-year German government bonds, known as bunds, were marked 7 basis points higher at 0.318% by 3:00 pm Frankfurt time, a four-week high, as investors re-priced inflation risks in both the region's biggest economy and the broader Eurozone. The European single currency was also on the move, rising more than 1% against the U.S. dollar to a 9-month high of 1.1305. Germany's 2-year government bonds, known as schatz, traded at -0.575%, the highest level in more than a year.
Draghi defended the Bank's ultra-loose monetary policy stance -- which includes €60 billion in monthly bond purchases and a -0.4% rate on cash left overnight inside the Eurosystem of central banks -- and said that failing to act as aggressively as they did at the peak of the region's financial crisis would have caused "permanent damage to the economy."
"Now we can be confident that our policy is working and that those risks have abated," Draghi argued in a speech to the ECB Forum on Central Banking in Sintra, Portugal. "The threat of deflation is gone and reflationary forces are at play. And since one of the drivers of inflation today is positive supply developments, this should feed back positively into potential output rather than produce hysteresis.
"In these conditions, we can be more assured about the return of inflation to our objective than we were a few years ago," he added.
The early signal of a return to more standard monetary policies, at least in the medium term, could provide another leg up for European stocks, which have outperform their U.S. peers so far this year on a dollar adjusted basis.
Bank of America Merrill Lynch research notes that European stocks perform well when the three-month moving average of Eurozone manufacturing PMI readings is greater than 55 points, providing annualised returns on the Stoxx Europe 600 index, the broadest measure of regional shares, of around 21%.
IHS Markit's Manufacturing PMI reading has topped 55 for the past four months and was last measured at a 74-month high of 57.3 in June.
"While there are still factors that are weighing on the path of inflation, at present they are mainly temporary factors that typically the central bank can look through," Draghi said Tuesday in Portugal. "However, a considerable degree of monetary accommodation is still needed for inflation dynamics to become durable and self-sustaining. So for us to be assured about the return of inflation to our objective, we need persistence in our monetary policy."
Easy -- but not abnormal -- monetary policy, a growing economy and the absence of near-term electoral risks paint a compelling investment case for European stocks.