The ECB: on a mission to stabilise European peripheral bond yields
At its July meeting, the ECB not only raised key rates for the first time in a long time but also explained how it proposed to prevent yields on the sovereign bonds of various eurozone member states from drifting apart. In doing so, the ECB is again pushing the scope of its mandate to the limit.
Not only has it summarily created a new instrument in the so-called Transmission Protection Instrument (TPI) but it has also introduced a new term into the debate. We do not yet have the exact details on what it entails. In addition, the ECB reaffirmed its intention to use to full potential the flexibility of the preceding PEPP and to reinvest monies with flexibility as they fall due. This reaffirmation came promptly at the beginning of August, and the holdings of German, French and Dutch bonds fell by EUR 18.9 billion. The monies that fell due were immediately reinvested into government securities, primarily from Italy, but also Spain, Portugal and Greece. The flexibility of the PEPP has often been called the ECB’s first line of defence. But is this defence strong enough? The next few months will soon tell. A critical factor is the premium that Italian sovereign bonds pay over German sovereign bonds. The differential is currently around 250 basis points and thus around 150 basis points higher than last year’s level. No doubt the fresh government crisis in Italy played a part in this. On the other hand, the 1% increase in GDP in Italy in the second quarter of 2022 was a positive surprise, which should also help cast a positive light on Italian sovereign bonds.
“We expect that the steady flow of money from the ECB should be enough
to bring the yield differential back down.”
Dr Volker Schmidt
Is there a risk of credit spreads drifting further apart? No, we expect that the steady flow of money from the ECB should be enough to bring the yield differential back down. However, for this to happen, a stable government that the financial markets can trust must be elected on 25 September 2022. Only in August rating agency Moody’s changed the outlook on Italy’s Baa3 rating – the lowest investment grade rating – to negative, thus making it clear once again how urgent a stable political framework and the resumption of economic reforms is.
Figure: Yield on 10-year sovereign bonds
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