The ECB urgently convenes its governing council in the face of the escalation in risk premiums

The European Central Bank (ECB) has called an extraordinary meeting of its governing council for this Wednesday due to the rise in risk premiums in southern European countries after the announcement of interest rate hikes last Thursday. “The Governing Council will have a meeting ad hoc this Wednesday to discuss current market conditions”, confirmed a spokeswoman for the institution. The meeting has been precipitated after the debt of some countries, including Spain, marked its maximum since 2014. The yield on the ten-year Spanish bond exceeded 3% on Tuesday due to the prospects of higher rate hikes and a deterioration of the economy. This trend has occurred throughout the southern arc of Europe: in Greece it has exceeded 4.5%; in Italy, 4%, and in Portugal, 3%.

Faced with this rapid deterioration in risk premiums, Isabel Schnabel, a member of the institution’s executive committee, had stated: “Our commitment to the euro is our anti-fragmentation tool. This commitment has no limits”. The warning from Schnabel, who insisted that new instruments will be launched if necessary, comes after the more aggressive tone printed by the Eurobank has not taken long to move to the risk premiums of the peripheral countries. The markets are considering that the ECB could put on the table a greater repurchase of peripheral bonds with the reinvestments, the debt programs launched in recent years or even a new instrument to curb risk premiums.

Isabel Schnabel, member of the Executive Committee of the ECB, in a file image.
Isabel Schnabel, member of the Executive Committee of the ECB, in a file image.Ralph Orlowski (Reuters)

The markets expected that the ECB would already have some new instrument to cushion the damage that the countries of the periphery could suffer due to the rise in rates that will start next July. But that didn’t happen. The president of the Eurobank, Christine Lagarde, gave the highest priority to the fight against inflation. And although she did sing a whatever it takes [lo que sea necesario], seemed not to have convinced the markets. “We will not tolerate fragmentation that prevents the transmission of monetary policy throughout the entire euro zone. We have shown in the past, and we will in the future: we will deploy new instruments when necessary”, affirmed the head of the ECB. And in any case, she said that she would apply the necessary “flexibility” to the bond purchases that will be made with the maturities of the debt, which analysts estimate at around 200,000 million euros per year.

However, the markets quickly punished the countries of southern Europe, which accumulate the largest debts and deficits in the euro zone. The prospects that the Federal Reserve this Wednesday could go further have contributed to these increases, since the markets fear that a sharp rise in rates will end up causing a recession that will spread to other countries in two ways: dragging other central banks to that dynamic to make money more expensive or by pure contagion effect. The mere announcement of the extraordinary meeting in Frankfurt immediately relaxed the debt markets: the Italian ten-year bond fell to 3.9%; the Spanish, to 2.96%, and the Portuguese, to 2.95%. Stock markets have risen and the euro has appreciated against the dollar.

At a conference in Paris, Schnabel admitted on Tuesday that the “rise in sovereign risk premiums has accelerated, liquidity conditions have become more challenging and daily changes in bond yields have increased.” This fragmentation of the debt markets, according to the German, can put in check the transmission of the monetary policy dictated from Frankfurt. Therefore, he warned that, if this trend continues, they will use all that “flexibility” with reinvestments in “a very short period of time” if it is concluded that “the transmission of the policy is at risk.” The ECB is even willing to go further.

He knows in depth all the sides of the coin.


Existing and new tools

“We will react to new emergencies with existing and potentially new tools,” added the German, who recalled the ECB’s reaction with massive debt purchases to combat the pandemic. “These tools could be different, with different conditions, duration and guarantees to stay firmly within our mandate. But there can be no doubt that, if and when necessary, we can and will design and deploy new instruments to ensure the transmission of monetary policy and thus our core price stability mandate,” she added. .

The ECB took it for granted that the risk premium of the southern countries was going to increase because it had to reflect the situation of their finances. However, he believed that they are now playing with an important asset: a tourist season that seems exceptional and that will prevent them from entering a recession. Something that he did not see so clearly for other economies with greater industrial weight, such as Germany. This should convince investors that this situation is not like the one in 2012 and prevent them from speculating on the bonds of southern Europe. However, risk premiums soared after the press conference. This Tuesday, that of Greece reached 298 points; that of Italy, 247, that of Spain, 137, and that of Portugal, 135. The last time these countries reached those levels was in May 2020, in the midst of the first wave of the pandemic.

“We believe that the spread between Italian and German 10-year bonds would need to widen by another 100 basis points or so, to around 3.5%, to force the ECB to make a stronger formal statement of support for bonds. peripherals. And even then, any initial announcement can be disappointing, ”says an analysis by the consultancy Capital Economics released this Thursday.

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