These plans have sharply raised borrowing costs in southern European countries, leading to calls for the central bank to provide more details about how it is proposing to prevent the eurozone bond market from fragmenting.
“The Board of Directors has decided that it will apply the flexibility to reinvest outstanding recoveries in the PEPP portfolio, with a view to maintaining the operation of the monetary policy transmission mechanism,” 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.
Yields on Italian 10-year bonds fell slightly after news of the European Central Bank’s emergency meeting, falling to just under 4% from 4.3% on Tuesday, according to Capital Economics.
“The ECB’s carefully communicated strategy has been to end asset purchases, then raise rates, starting with small increments and accelerating if necessary,” said Kit Juckes, strategist at Societe Generale. “This strategy is in all sorts of problems today.”
At the end of 2021, Greece had the highest debt-to-GDP ratio in Europe at 193%. Italy came next with 151%.
Panic in the ocean
Europe is in better shape than it was the last time the European Central Bank raised interest rates in 2011.
The Greek economy, in particular, has been outpacing growth expectations, and has favorable conditions on its debt that make repayment less worrisome. But that is not the case in Italy, which will need to refinance its liabilities sooner, and where growth has been slowing.
“Italy has not done enough serious reforms,” said Holger Schmieding, chief economist at Berenberg Bank.
The turmoil in the bond market since last Thursday’s European Central Bank meeting has added to the pressure on the bank.
“With memories of the European debt crisis still fresh, investors are wondering how and in what circumstances ECB President Christine Lagarde will make good on her promise… to act against ‘excessive fragmentation’ if necessary after the end of net asset purchases,” Schmieding wrote in a note on Wednesday. Titled “Panemic in the Limbs: Time for the European Central Bank to Show Its Hand”.
Like the European Central Bank, it faces the huge challenge of trying to raise interest rates and pull out years of stimulus without causing a recession. But it only has to take one economy into account.
“An additional challenge for the ECB is that its policies affect borrowing costs in 19 economies with different fundamentals,” Schmieding commented.
