June 16, 2022: Borrowing costs for eurozone governments jumped ahead of the first interest rate hike by the European Central Bank in a decade, rekindling memories of its debt crisis.
Soaring yields – or interest – that governments must pay investors who buy sovereign bonds prompted the ECB to hold an emergency meeting on Wednesday.
AFP answers three questions about the situation:
– What is happening with the yields? –
Last week, the ECB announced that it would end at the end of the month a massive bond-buying program it had been rolling out since 2014.
Worth five trillion euros ($5.4 trillion), the program was launched in an attempt to boost prices and economic growth as deflation loomed.
The tool worked by buying bonds in the market, lowering or maintaining interest rates for states, corporate investors and consumers.
The move will be followed by a quarter-point rate hike, the first since 2011, in a bid to rein in record inflation.
Since then, the yields paid by governments have risen, but unevenly, with the most indebted countries in the euro zone being hit by higher rates.
The yield spread between Italian bonds and those of Germany, the largest economy in the eurozone, widened.
The yield on Italian 10-year bonds rose above 4% on Monday, a level not seen in eight years.
“An increase in yields and spreads is normal,” said Gilles Moec, chief economist at Axa Investment Managers.
– What’s the risk? –
The widening spread between German and Italian yields, which widened to 2.5 percentage points this week, raised the specter of a repeat of the euro zone debt crisis of 2011-2012.
At the time, Italy’s borrowing costs were five percentage points higher than Germany’s. Last year, the gap was about 1.35 percentage points.
“Italy’s financial conditions will deteriorate much faster than elsewhere in the eurozone” as the country’s economic growth is weaker than elsewhere, said Franck Dixmier, global head of fixed income at Allianz. Global Investors.
Gilles Moec, chief economist at Axa Investment Managers, said things could move fast enough to “cast doubt on the Italian government’s plans of three months ago”.
– What signals is the ECB sending? –
Worried about widening spreads, the ECB held its first unscheduled meeting since 2020 on Wednesday, when it met to respond to the economic crisis triggered by the Covid pandemic.
Policymakers said they would speed up work on “a new anti-fragmentation instrument”, which could be used to deal with further tensions in the bond market.
The ECB has also pledged to “apply flexibility” to the reinvestment of maturing bonds under its pandemic-era debt purchase program to target countries at risk.
“This means that while waiting for the (anti-fragmentation) instrument, the ECB will use reinvestments in the (pandemic program), perhaps buying Italian debt,” Dixmier said.
Details of the instrument remain unclear, but it’s a welcome move, he said.
“It is a necessary and sufficient condition for the ECB to be completely free in the conduct of its monetary policy, so that it is not handicapped or impeded in its rate hikes,” Dixmier said.
Markets seem to approve as yields fell after the ECB meeting.