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Spreads and yields: Ghosts of eurozone debt crisis return

June 16, 2022: The borrowing costs of eurozone governments have jumped in anticipation of the first interest rate hike by the European Central Bank in a decade, reviving memories of its debt crisis.

The surge in yields — or interest — that governments must pay to investors who buy sovereign bonds prompted the ECB to hold an emergency meeting on Wednesday.

AFP answers three questions about the situation:

– What's happening with yields? –

Last week, the ECB announced that at the end of the month it would end a massive bond-buying programme that it had deployed since 2014.

Worth five trillion euros ($5.4 trillion), the scheme was launched to try to stoke prices and economic growth as deflation loomed.

The tool worked by buying up bonds on the market, pushing down or holding down interest rates for states, corporate investors and consumers alike.

The move will be followed by a quarter-point rate increase, the first hike since 2011, in an effort to tame record inflation.

Since then, the yields paid by governments have gone up, but in an uneven manner, with the more indebted eurozone countries hit by higher rates.

The spread in yields between Italian bonds and those of Germany — the eurozone's top economy — has widened.

The rate for 10-year Italian bonds exceeded four percent on Monday, a level not seen in eight years.

“An increase in yields and spreads is normal,” said Gilles Moec, chief economist at Axa Investment Managers.

– What's the risk? –

The growing gap between German and Italian yields, which widened to 2.5 percentage points this week, has raised the spectre of a repeat of the eurozone's 2011-2012 debt crisis.

At the time, Italy's borrowing costs were five percentage points higher than those of Germany. Last year, the spread stood at around 1.35 percentage points.

“The financial conditions of Italy will deteriorate much faster than elsewhere in the eurozone” as the country's economic growth is weaker than in other places, said Franck Dixmier, global head of fixed income at Allianz Global Investors.

Gilles Moec, chief economist at Axa Investment Managers, said things could move fast enough to “put in doubt the Italian government projects from three months ago”.

– What signals is the ECB sending? –

Worried about the widening spreads, the ECB on Wednesday held its first unscheduled meeting since 2020, when it met to respond to the economic crisis sparked by the Covid pandemic.

The policymakers announced that they would quicken work on “a new anti-fragmentation instrument”, which could be used to tackle further bond market stress.

The ECB also vowed to “apply flexibility” to the reinvestment of maturing bonds under its pandemic-era debt purchasing programme to target at-risk countries.

“This means that while waiting for the (anti-fragmentation) instrument, the ECB will use reinvestments in the (pandemic programme), maybe by buying Italian debt,” Dixmier said.

The details of the instrument remain fuzzy, but it is a welcome move, he said.

“It's a necessary and sufficient condition for the ECB to totally free in how it conducts its monetary policy, so that it is not handicapped or hampered in its rate hikes,” Dixmier said.

Markets seem to approve as yields fell following the ECB meeting.


Posted on: 2022-06-16T22:57:47+05:00


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