Missteps are likely to be followed by abrupt asset price adjustments and financial market disruption. Oppositely, if the normalisation phase is excessively prolonged, build-up of vulnerabilities in the financial system may be exacerbated. Either way, normalisation entails risks. Steady and well-communicated policy tightening will be important to manage market expectations. In this regard, it will be important to follow developments in government bond markets.
The recent correction in equity markets was accompanied by a surge in implied volatility. The increase in implied volatility on longterm German government bonds over the same period was modest, and it remains well below its average level over the past ten years. Finally, normalisation of monetary policy could be complicated by continued subdued inflation.