San Francisco Frontiers - ECB moves to ease bond stress after surprise meeting

A week after its regular policy gathering, the Frankfurt-based institution held a surprise "ad hoc meeting" to address the development in "market conditions".

With inflation soaring, the ECB drew a line under years of ultra-loose monetary policy last Thursday, ending its massive bond-buying stimulus at the end of the month and announcing a long-awaited interest rate hike for July.

Consumer prices rose in the eurozone at an 8.1-percent pace in May, an all-time high for the currency club and well above the ECB's own two-percent target.

But following the switch, the spread between yields of German government bonds and those of more indebted eurozone members -- a measure of bond market stress -- began to rise.

The coronavirus pandemic had "left lasting vulnerabilities in the euro area economy which are indeed contributing to the uneven transmission" of its policy, the ECB said in a statement.

In response, the ECB said it would "apply flexibility" to the reinvestment of maturing bonds under its pandemic-era debt purchasing programme to target at-risk countries, widely considered to include Italy, Spain, Greece and Portugal.

It would also speed up work on "a new anti-fragmentation instrument", which could be used to tackle further bond market stress.

- Crisis tool -

On Tuesday, ECB executive board member Isabel Schnabel said the bank would "not tolerate" unwarranted increases in borrowing costs that would "undermine" the bank's policy.

Schnabel said the ECB's response to the risks of fragmentation would "depend on the situation we are facing", but insisted that the bank's commitment had "no limits".

Hanging over the decision are memories of the eurozone debt crisis, when primarily southern states came under intense pressure as their borrowing costs soared, making their debts harder to finance.

Since the meeting last week, the spread between Italian and German government debt had risen to levels not seen since the very start of the pandemic in March 2020.

But yields on Italian 10-year bonds dipped following the announcement of the meeting, reducing the spread with German government debt.

Eurozone stock markets also rose after falling this week ahead of a regular US Federal Reserve meeting where policymakers could hike rates even higher than expected to combat decades-high inflation.

The ECB's announcement was the "minimum" policymakers could come away with from Wednesday's meeting, said Jack Allen-Reynolds, senior Europe economist at Capital Economics.

The planned sums from the pandemic-era programme were "too small to halt a full-blown market panic", he said.

- 'A lot further' -

The ECB brought an end to net purchases under the 1.85-trillion-euro ($1.94-trillion) scheme in March this year, but only a fraction will be available for reinvestment.

The tool being designed by the ECB "will need to go a whole lot further", Allen-Reynolds said, warning that "debt sustainability will be a much bigger issue" if interest rates rise further than currently expected.

The ECB's plan to up interest rates by a quarter percentage point at its meeting on July 21 would be its first hike in over a decade.

The central bank's interest rates currently sit at historic lows, including a minus 0.5 deposit rate that effectively charges banks to park their cash at the ECB overnight.

The ECB has plotted out another hike at its September meeting, but a number of policymakers are eager to move faster to quash inflation and catch up with other major central banks.

L.Lopez--SFF