European Central Bank announces efforts to end bond market turmoil.

The European Central Bank said on Wednesday it would take further steps to guard against spiraling borrowing costs in some highly indebted European countries. The announcement came after an unexpected meeting of the bank’s board of governors amid growing concerns over the bond market.

Borrowing costs for eurozone countries have diverged sharply in recent weeks in anticipation of an interest rate hike by the bank. This widening gap, known as fragmentation, could harm the bank’s ability to manage monetary policy in the 19 countries that use the euro. Christine Lagarde, president of the bank, said last week that policymakers would not tolerate it.

On Tuesday, Isabel Schnabel, a member of the bank’s board, described the fragmentation as “a sudden break” in the relationship between government borrowing costs and economic fundamentals.

Last week, the bank said it could consider using reinvestment of proceeds from maturing bonds in its €1.85 trillion ($1.9 trillion) pandemic-era bond purchase program. dollars) to avoid this fragmentation, by buying bonds that would help reduce borrowing costs for governments. .

Wednesday, the The bank confirmed that it would make these bond purchases flexibly and “accelerate” the design of a new tool to combat market fragmentation, without providing further details.

The divergent spreads emerged when the central bank changed its policy to fight inflation, which, at an annual rate of 8.1%, is the highest level since the creation of the euro in 1999. to end bond-buying programs that have large amounts of government debt, the bank also said it would raise interest rates in July for the first time in more than a decade. This decision will be followed by another, probably larger, rate hike in September.

As traders bet on the level to which the central bank will raise interest rates to contain inflation, concerns are growing over the impact of the rate hike on highly indebted countries. Italy, which has the second-highest public debt-to-GDP ratio in the euro zone, saw yields on its 10-year bonds climb above 4% this week for the first time since 2014. The spread between its yield and that of Germany, considered the region’s benchmark, reached its highest level since the start of 2020, when the pandemic rocked bond markets.

“The pandemic has left lasting vulnerabilities in the eurozone economy that are indeed contributing to the uneven transmission of our monetary policy normalization across jurisdictions,” the bank said in a statement on Wednesday.

The announcement sent bond yields lower across the eurozone. Italy’s 10-year yield fell to 3.71% from 4.17% the previous day. Its gap, or gap, with Germany’s performance has also narrowed.

The European Central Bank faces a particular challenge as it determines monetary policy in a range of economies. On the one hand, it is tightening its monetary policy in the face of high “undesirable” inflation, but on the other hand, it is trying to ease the financing conditions of certain countries through bond purchases.

“It will take a few days to see how the markets digest this, let alone more details from the ECB,” Claus Vistesen, an economist at Pantheon Macroeconomics, wrote in a note to clients. “The presence of an anti-fragmentation tool means the ECB has more room to raise rates without spreads widening excessively.”

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