ECB to firm up plans to deal with tensions in bond markets

The European Central Bank is set this week to step up its commitment to support debt markets in vulnerable eurozone countries if they are hit by a selloff, as policymakers prepare to raise rates for the first time in over a decade.

A majority of the board’s 25 members are expected to back a proposal to create a new bond-buying program if needed to counter borrowing costs for member states, like Italy, spiraling out of control, according to several people involved in the discussions.

Even without a new program, the ECB already has an additional 200 billion euros to spend buying distressed government debt under its existing bond-buying program. These 200 billion euros would come from the anticipation of the reinvestments of assets maturing up to one year.

Italian government debt rallied on Monday morning, pushing the yield on the country’s benchmark 10-year bond up 0.1 percentage point to 3.3%.

The spread between Italy’s and Germany’s 10-year borrowing costs, a key measure of perceived financial risk in the eurozone, narrowed by 2.14 percentage points at the end of the week last at 2.07 percentage points. The spread last week reached its highest level since a sell-off in southern European bond markets at the start of the pandemic in 2020.

Rates officials, who meet in Amsterdam on Wednesday and Thursday, are likely to clash over when to stop buying more bonds. Some plan to call for a halt in purchases as early as Thursday, several weeks ahead of schedule, although they admit only a minority might back the idea.

The bank is under pressure to respond to record inflation, but has lagged its counterparts in the US and UK in tightening monetary policy. Many board hawks have accepted that they will need to provide more support to bond markets to pave the way for a more aggressive rate hike.

Almost all board members agree that the ultra-loose monetary policy it has pursued for more than a decade must end. A hike of at least 25 basis points is almost certain to occur at the ECB’s next monetary policy meeting on July 21. The deposit rate is now minus 0.5%.

Citizens in the region are facing a rising cost of living, made worse by the Russian invasion of Ukraine. Eurozone consumer prices rose 8.1% in the year to May – quadrupling the ECB’s 2% target and doubling the previous record high since the launch of the single currency in 1999 – forcing governments to pay subsidies to cushion the impact of rising energy and food prices. household prices.

Line chart showing eurozone inflation has exceeded ECB target

However, some are concerned about the market fallout from higher rates and want a firmer commitment to launch a new bond-buying program to counter any unwarranted increases in borrowing costs for heavily indebted countries.

ECB President Christine Lagarde said in a blog last month: “If necessary, we can design and deploy new instruments to secure the transmission of monetary policy as we move forward on the road to policy normalization, as we have shown many times in the past.”

Several board members said they would support adding similar language to his statement on Thursday, building on a promise made after his April meeting to maintain flexibility when his goal of price stability is threatened.” under stressful conditions.

The central bank has previously said its ongoing €20bn-a-month asset purchase program will not end until early July and that “sometime” after that it will consider raising interest rates.

Policymakers planning to call this week for an immediate halt to additional bond purchases say there is no longer any justification for pursuing a policy aimed at boosting inflation. Others insisted it was more credible to stick with the bond-buying plan until early July. The ECB declined to comment.

Carsten Brzeski, head of macro research at ING, said bringing forward the end of bond buying by a few weeks would be “a distinct hawkish surprise” and could even open the door to the possibility of raising interest rates before its July 21 meeting.

The ECB has bought more than 4.9 billion euros of bonds in total, more than a third of the gross domestic product of the euro zone, since the launch of its quantitative easing program to deal with the double threat of deflation and sovereign debt crisis in 2014.

Over the past two years, it has bought more than all the additional bonds issued by the 19 eurozone governments, giving it a big grip on borrowing costs in the region.

The ECB has also been slower to stop buying more bonds than most Western central banks. Some, like the US Federal Reserve, have even begun to shrink their balance sheets by not reinvesting proceeds from maturing bonds.

Additional reporting by Adam Samson

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