A dovish European Central Bank (ECB) has driven ETF investors to riskier parts of the fixed income market in Europe while in the US, short-duration bond ETFs are in high demand in response to the Federal Reserve’s largest hike in two decades.

According to data from Ultumus, the iShares $ Treasury Bond 3-7yr UCITS ETF (CBU7) saw $602m inflows in the week to 6 May, the most across all European-listed ETFs, while investors poured $345m and $105m into the iShares $ Short Duration Corp Bond UCITS ETF (SDIG), the second-highest, and the iShares $ Ultrashort Bond UCITS ETF (ERND), respectively.

Meanwhile, investors opted for risk-on European fixed income exposure including the iShares Core € Corp Bond UCITS ETF (IEAC) which saw $332m inflows over the same period while the iShares Italy Govt Bond UCITS ETF (IITB) captured $148m assets as the ECB kept its monetary policy unchanged despite eurozone inflation spiking to a record 7.5% in March.

At the other end of the spectrum, the Lyxor Euro Government Bond 1-3Y UCITS ETF (MTA) and the iShares € Corp Bond 1-5yr UCITS ETF (SE15) both saw $99m redemptions, respectively.

Explaining the decision to maintain rates at current levels, European Central Bank President Christine Lagarde said stagflation is not the central bank’s base case even though the war in Ukraine has slowed growth and caused a spike in inflation.

Commenting on the central bank divergence, Paul Craig, portfolio manager at Quilter Investors, said: “The ECB is keeping their distance from the Fed and Bank of England. Although inflation is at record levels for the bloc, ECB board members will be most concerned with the virus outbreak and economic deterioration, in Germany notably.

“With such a broad array of inflation views on the governing council we expect it will be some time before rate hikes are on the table in the eurozone.”

This is in stark contrast to the situation where the Fed hiked rates by 50 basis points to a range of 0.75% to 1%, its fastest increase since 2000, in a bid to quell inflation which has skyrocketed to 8.5%.

Nicholas Hyett, investment analyst at Wealth Club, said central bankers are “stuck between a rock and a hard place” amid rising inflation and slowing growth.

Inflation is being driven by international supply constraints rather than economies running hot – and that means higher interest rates’ ability to dampen demand and take the air out of price inflation is less effective than it would usually be,” Hyett added.

Looking forward, central bankers are walking a tight rope between tackling inflation and tipping the economy into a recession by raising interest rates too quickly.

As Dan Boardman-Weston, CEO and CIO at BRI Wealth Management, warned: “This year will likely be pivotal for monetary policy and the risks of a misstep and a hard landing seem to be increasing.”

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