European Central Bank strengthens plans to fend off bond market pressures

The European Central Bank is preparing this week to reinforce its commitment to support the debt markets of weak eurozone countries if they are sold off, as policy makers prepare to raise interest rates for the first time in more than a decade.

The bulk of the 25 board members are expected to support a proposal to create a new bond-buying program if needed to meet the borrowing costs of member states, such as Italy, that have spiraled out of control, according to several people involved in the discussions.

Even without a new plan, the European Central Bank already has an additional €200 billion to spend on buying stressed government debt under its current bond-buying programme. This €200 billion will come from providing reinvestments for assets maturing for up to a year.

Italian government debt rose on Monday morning, bringing the yield on the major 10-year bonds down by 0.1 percentage point to 3.3 per cent.

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

Interest rate setters, who meet in Amsterdam on Wednesday and Thursday, are likely to clash over when to stop buying more bonds. Some plan to call for purchases to be halted as soon as Thursday, several weeks ahead of schedule, although they acknowledge that only a minority may support the idea.

The bank is under pressure to respond to record high inflation, but has lagged behind its US and UK peers in tightening monetary policy. Many of the board’s hawks agreed that they would need to provide more support to the bond markets to clear the way for them to be bolder in raising interest rates.

Almost every council member agrees that the ultra-loose monetary policy he’s been following for more than a decade must come to an end. A rise of at least 25 basis points is sure to happen at the next ECB policy meeting on July 21st. The deposit rate is now 0.5%.

Citizens of the region face a rising cost of living, exacerbated by the Russian invasion of Ukraine. Eurozone consumer prices rose 8.1 per cent in the year to May – quadrupling the European Central Bank’s 2 per cent target and doubling the previous rise since the single currency was launched in 1999 – forcing governments to pay subsidies to cushion the impact of rising energy and food. Prices for families.

However, some are concerned about the market fallout from the rate hike and want a stronger commitment to launch a new bond-buying scheme to counter any unjustified increase in borrowing costs in heavily indebted countries.

“If needed, we can design and deploy new tools to secure monetary policy transmission as we move along the path of policy normalization, as we have shown on numerous occasions in the past,” European Central Bank President Christine Lagarde said in a blog last month.

Several council members said they would support adding similar language to its statement on Thursday, building on a promise made after its April meeting to maintain flexibility when the price stability target is threatened “under tense conditions”.

The central bank said earlier that its ongoing €20 billion per month asset purchase program would not end until early July, after which only “some time” it would consider raising interest rates.

Policy makers who plan to call for an immediate end to additional bond purchases this week believe there is no longer any justification to continue a policy designed to increase inflation. Others insisted that it was more credible to stick with the plan to continue buying bonds until early July. The European Central Bank declined to comment.

Offering to end bond-buying for a few weeks would be an “obvious hawkish surprise” and could open the door to the possibility of a rate hike ahead of their July 21 meeting, said Carsten Brzeski, head of macro research at ING.

The European Central Bank has bought more than €4.9 trillion in bonds in total, equivalent to more than a third of the eurozone’s gross domestic product, since launching its quantitative easing program to counter the dual threat of deflation and the 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 wide leverage over the region’s borrowing costs.

The European Central Bank has also been slower to stop buying more bonds than most Western central banks. Some, such as the US Federal Reserve, have even begun to shrink their balance sheets by not reinvesting maturing bond proceeds.

Additional reporting by Adam Samson