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

CNN

By Clare Sebastian and Julia Horowitz, CNN Business

The European Central Bank has tried to calm fears of a debt crisis by promising “flexibility” in the management of its huge balance sheet and accelerating work on new ways to reduce stress on heavily indebted countries like the Italy and Greece as Interest Rates Rise.

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

These plans have sharply increased borrowing costs in southern European countries, prompting the central bank to provide more details on how it proposes to prevent the fragmentation of the eurozone bond market. .

In response to the sharp sell-off in the market, which brought back memories of the region’s debt crisis more than a decade ago, the central bank held a rare and unscheduled meeting on Wednesday. It has promised to deploy money from maturing bonds it bought under its Pandemic Emergency Purchase Program, or PEPP, to ease tensions.

“The Governing Council has decided that it will apply some flexibility in the reinvestment of maturing repayments in the PEPP portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism,” he said in a statement. a press release following the extraordinary meeting.

The spread between German and Italian 10-year government bond yields was at its highest 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 on the announcement of the ECB’s emergency meeting, falling to just below 4% from 4.3% on Tuesday, according to Capital Economics.

“The ECB’s carefully communicated strategy was to end asset purchases and then raise rates, starting in small increments and accelerating if necessary,” noted Societe Generale strategist Kit Juckes. “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 followed with 151%.

“Panic in the Outskirts”

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

Greece’s economy, in particular, has exceeded growth expectations, and it has favorable terms on its debt that make repayment less of a concern. But this is not the case in Italy, which will have to refinance its debts earlier and where growth is lagging.

“Italy has not done enough serious reforms,” ​​said Holger Schmieding, chief economist at Berenberg Bank.

And turmoil in the bond market since last Thursday’s ECB meeting has piled pressure on the bank.

“With memories of the European debt crisis still fresh, investors are wondering how and under what circumstances ECB President Christine Lagarde would keep her promise… to act against ‘excessive fragmentation’ if needed after an end to net asset purchases,” Schmieding wrote in a note on Wednesday titled “Panic in the Periphery: Time for the ECB to show its hand.”

The U.S. Federal Reserve is also meeting on Wednesday to discuss interest rates and is expected to raise U.S. rates by three-quarters of a percentage point, something it hasn’t done since 1994.

Like the ECB, it faces the enormous challenge of trying to raise rates and withdraw years of stimulus without causing a recession. But it must take into account only one economy.

“The additional challenge for the ECB is that its policies affect borrowing costs in 19 economies with different fundamentals,” Schmieding commented.

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