The ECB accelerates the creation of a mechanism to curb future sovereign debt crises

The European Central Bank (ECB) finally shows its teeth to the markets. The rhetoric has finally given way to the facts and the institution chaired by Christine Lagarde promised to speed up work to create instruments to stop future sovereign debt crises in the euro zone. The decision was made at an emergency meeting called early this Wednesday, with risk premiums skyrocketing after the announcement of interest rate hikes last week. Especially the Italian, who was already in the danger zone. In a statement, the Governing Council of the ECB has indicated the two steps it has decided to take. Immediately, it has given the green light to reinvest “with flexibility” the debt maturities of the extinct program to combat the pandemic (PEPP, in its acronym in English). In other words, this portfolio, which amounts to 1.7 trillion euros, can be allocated above all to the countries that are most affected by market attacks, including Greece. And in a second phase, a new anti-crisis mechanism will be launched.

Lagarde had already warned the markets that she would not tolerate an attack on sovereign debt like the one in 2012. She failed to convince them. With a more aggressive tone and a path of interest rate hikes ahead, the markets immediately went after the debt of the countries of southern Europe. In particular, on that of Italy, which in just six months faces key elections for Europe. But the cost of debt soared across the south: Greek debt yields on Tuesday had topped 4.5%; that of Italy, 4%; and that of Portugal, 3%. In Spain it had also climbed to 3%, the highest level since 2014. And that on the verge of a new increase in interest rates in the United States that could make the markets even more nervous.

Isabel Schnabel, a member of the Executive Committee of the ECB, came out on Tuesday to try to calm the turmoil. The German again warned that the Eurobank will do everything in its power to stop the divergences in the euro zone that prevent the effective deployment of monetary policy, which faces a new era in which it leaves behind negative rates and massive purchases of debt. The entity will not only try to tackle the very high inflation, which in the Baltic countries does not fall below the digits, but also the “fragmentation” of the debt markets. “This commitment has no limits,” she settled.

“Flexibility” in purchases

However, the ECB decided that it was time to act. The governors of Spain, Germany or Austria canceled their public acts on Wednesday and the Governing Council of the ECB met this Wednesday at 11 in the morning to address the instability in which the markets are installed. In a brief statement at the end of the meeting, the institution has confirmed that the pandemic has left “lasting vulnerabilities in the economy” that contribute to the “uneven transmission” of its monetary policy that prevent its process of “normalization” between jurisdictions and returns to commit to combating this inequality between markets.

To begin with, the “flexibility” guaranteed by Lagarde will no longer be a promise. From now on, the ECB will be able to acquire priority debt from countries in trouble to contain their risk premiums through debt reinvestments from the PEPP. That includes Greek bonds, which could not be purchased under the traditional purchase program (APP). In other words, if a German bond matures, the Eurobank will be able to reinvest it in one from Portugal, for example. Frankfurt believes that those 1.7 billion PEPP may be enough, but he prepares another weapon in case it is not. The ECB has instructed its technicians to “accelerate the finalization of the design of a new anti-fragmentation instrument” that will subsequently have to be examined by the Council.

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That is, according to sources consulted, the heart of the matter: some members of the Governing Council suggest that new conditions should be imposed on the countries that benefit from this instrument, while others believe that those contemplated in the European recovery plans are sufficient. It must also be defined when this mechanism can be activated. “There is no guarantee that [los miembros del Consejo] consensus on such a tool at the next policy meeting in July, so we could see spreads widen further before the new tool is implemented,” said Jack Allen Reynolds, economist at Capital Economics. However, its implementation can also propel the rise in rates by allaying that fear within the ECB. “Overall, this should also give the ECB the opportunity to raise key rates faster and more aggressively, as spread widening is limited to a certain extent,” says Ulrike Karstens, economist at DWS.

For now, the ECB’s decision has, in fact, been a breather for sovereign debt markets. Greece’s risk premium had fallen 32 basis points; that of Italy, 25 points; that of Spain, 15 points, and that of Portugal, 18. Waiting for the decision of the Federal Reserve, the stock markets rose, while the euro fell against the dollar after that movement was perceived as a small step back from hawks.

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