The European Central Bank (ECB) moved on Wednesday to address fears that the eurozone is on the brink of another debt crisis.
Government borrowing costs have soared in the eurozone’s periphery countries since the ECB unveiled plans last Thursday to raise interest rates to curb inflation.
After an emergency meeting on Wednesday, the ECB pledged to accelerate plans to create a “new anti-fragmentation instrument” amid a widening gap in the cost of borrowing between more stable borrowers such as Germany and member states deemed to be more vulnerable.
There was little detail on how the ECB’s new instrument will work but some analysts believe it could be an updated version of the programme that allowed the ECB to tackle market fragmentation by buying €220 billion of government bonds between 2010 and 2012.
“Today the Governing Council met to exchange views on the current market situation,” said the ECB.
“Since the gradual process of policy normalisation was initiated in December 2021, the Governing Council has pledged to act against resurgent fragmentation risks.
“The pandemic has left lasting vulnerabilities in the euro area economy which are indeed contributing to the uneven transmission of the normalisation of our monetary policy across jurisdictions.
“Based on this assessment, the Governing Council decided that it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism, a precondition for the ECB to be able to deliver on its price stability mandate.
“In addition, the Governing Council decided to mandate the relevant Eurosystem Committees together with the ECB services to accelerate the completion of the design of a new anti-fragmentation instrument for consideration by the Governing Council.”
James Athey, investment director at Abrdn, said: “The greatest trick the devil ever pulled was convincing the world he didn’t exist … a reference to the mysterious Keyser Sozé from the movie The Usual Suspects.
“The ECB equivalent would be that the greatest trick they could pull off would be to convince the world they had a powerful and credible tool to tighten spreads which could be used at any time.
“The announcement of an emergency meeting to discuss this topic will have rattled the nerves of investors who were short the higher beta bond markets. Their fear would have been that the ECB was one step closer to pulling off this trick.
“The statement released post this meeting didn’t really give the impression that anything is imminent.
“It confirmed what we already knew – that there is some flexibility in PEPP which is the first line of defence. It also suggested a greater urgency with respect to an anti-fragmentation tool.
“However the need to balance monetary policy needs versus legal limits is the difficult balancing act here and on that front we are none the wiser.
“I’d be surprised if the recent spread tightening is the end of this story. I don’t think the ECB has had its Keyser Sozé moment.”
Claus Vistesen, economist at Pantheon Macroeconomics, wrote in a note to clients: “It will take a few days to see how markets digest this, not to mention more details from the ECB.
“The presence of an anti-fragmentation tool means that the ECB has more room to raise rates without spreads widening excessively.”
Danske Bank chief strategist Piet Christiansen said: “They have sent a signal that they have fully committed to ensure the functioning of the monetary-policy transmission …
“They have also bought themselves some time.”
Ulrike Kastens, economist at DWS International GmbH, said: “This should also give the ECB the opportunity to raise key rates more quickly and aggressively, as spread widening is limited to a certain extent.”