European Central Bank tries to ease debt crisis worries after bond ‘panic’

At its regular meeting last week, the ECB confirmed plans to raise rates by 25 basis points in July – the first increase in 11 years – to fight inflation, and said more could follow in September if necessary. He also said he would stop buying European government bonds.

These plans have dramatically increased the cost of borrowing in the countries of southern Europe., leading to calls for the central bank to provide more details on how it proposes to prevent fragmentation of the eurozone bond market.

In response to a sharp sell-off in the market, which revived memories of the region’s debt crisis more than a decade ago, the central bank held a rare unscheduled meeting on Wednesday. He promised to use money from maturing bonds he bought through his Pandemic Emergency Purchase Program, or PEPP, to ease the burden.

“The Board of Governors has decided that it will be flexible in reinvesting maturities in the PEPP portfolio in order to keep the monetary policy transmission mechanism functioning,” it said in a statement after the extraordinary meeting.

The gap between German and Italian 10-year government bond yields was the widest since March 2020. earlier this week, according to Tradeweb. The spread between German and Greek bonds has also widened recently.

Italian 10-year bond yields edged slightly on news of the emergency ECB meeting, falling to just under 4% from 4.3% on Tuesday, according to Capital Economics.

“The ECB’s carefully communicated strategy was to stop buying assets and then raise rates, starting in small increments and accelerating as needed,” said Keith Jax, strategist at Societe Generale. “That strategy is in all sorts of trouble today.”

At the end of 2021, Greece had the highest debt-to-GDP ratio in Europe at 193%. Italy was next with a score of 151%.

“Panic in the Periphery”

Europe is in better shape than the last time the ECB raised rates in 2011.

The Greek economy, in particular, has outperformed growth expectations and has favorable terms on its debt that make it less risky to repay. But this is not the case for Italy, which will need to refinance its obligations earlier and where growth is slowing down.

“Italy hasn’t reformed enough,” said Holger Schmieding, chief economist at Berenberg Bank.

And the turmoil in the bond market following last Thursday’s ECB meeting put pressure on the bank.

“While the memory of the European debt crisis is still fresh, investors are wondering how and under what circumstances ECB President Christine Lagarde will deliver on the promise to … act against ‘excessive fragmentation’ if required after the end of net asset purchases,” Schmieding said. wrote in a note on Wednesday entitled “Panic on the periphery: ECB time to show its hand.”

US Federal Reserve also meets on Wednesday to discuss interest rates, and is expected to raise US rates by three-quarters of a percentage point, not seen since 1994.

Like the ECB, it faces a huge challenge in trying to raise rates and withdraw years of stimulus without triggering a recession. But this should take into account only one economy.

“An additional problem for the ECB is that its policies affect the cost of borrowing in 19 countries with different fundamentals,” commented Schmieding.

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