European Central Bank buckles down on price stability

London/New York (CNN Business)The European Central Bank is holding an unscheduled meeting Wednesday to discuss a sharp bond market sell-off that has revived memories of the region’s debt crisis more than a decade ago.

The bank would hold the “ad-hoc” meeting to discuss “current market conditions,” according to a spokesperson for the central bank. The meeting was reportedly due to begin at 5 a.m. ET.
The ECB left interest rates unchanged at its regular meeting last week but confirmed plans to raise the cost of borrowing by 25 basis points next month — its first rate hike in 11 years — and said a bigger hike could follow in September “if the medium-term inflation outlook persists or deteriorates.” It also said it would stop buying European government bonds.

The US Federal Reserve is also currently meeting to discuss interest rates, and is widely expected to raise US rates by three quarters of a percentage point, something it hasn’t done since 1994.

Plans by the ECB to hike rates and end years of support for the economy through bond purchases have pushed up borrowing costs sharply in some of Europe’s most heavily indebted countries, leading to calls for the bank to provide more details on how it proposes prevent the eurozone bond market fragmenting.

The gap between yields on 10-year German and Italian government bonds was at its widest since March 2020 on Monday, according to Tradeweb. The spread between German and Greek bonds has also widened recently.
The 10-year Italian yields fell back slightly on the news of the emergency ECB meeting, dropping to just below 4% from 4.3% Tuesday, according to Capital Economics.

“The ECB’s carefully-communicated strategy was to end asset purchases, then raise rates, starting in small increments and accelerating if needed,” noted Societe Generale strategist Kit Juckes. “This strategy is in all sorts of trouble today as the ECB meet to discuss their anti-fragmentation policy and tools.”
At the end of 2021, Greece had the highest debt-to-GDP ratio in Europe at 193%. Italy was next at 151%.

‘Panic in the periphery’

Europe is in better shape than it was the last time the ECB started raising rates.
Greece’s economy, in particular, has been beating expectations for growth, and it has favorable conditions on its debt that make repayment less of a concern. But that’s not the case in Italy, which will need to refinance its liabilities sooner, and where growth has been dragging.
“Italy has not done enough serious reforms,” said Holger Schmieding, chief economist at Berenberg Bank.
And the 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 asking how and under what circumstances ECB President Christine Lagarde would deliver on the promise … to act against ‘excessive fragmentation’ if required after the end of net asset purchases,” Schmieding wrote in a note Wednesday headlined “Panic in the periphery: time for the ECB to show its hand.”

The ECB has said it would step in and resume bond-buying if the situation deteriorates rapidly. Yet exactly when it would intervene isn’t clear, making investors increasingly nervous.
“The ECB can contain the problem if they want to,” Andrew Kenningham, chief Europe economist at Capital Economics said earlier this week. But they haven’t laid out their “pain threshold,” he added.
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