Inflation: why do the markets fear a return of the debt crisis in the euro zone?

Inflation: why do the markets fear a return of the debt crisis in the euro zone?
Written by madishthestylebar

The European Central Bank announced a tightening of monetary conditions in the face of accelerating inflation.

The European Central Bank in Frankfurt, June 15, 2022. (AFP / DANIEL ROLAND)

Financial markets tremble after the announcements of the European Central Bank. The monetary institution mentioned, Wednesday, June 15,

the prospect of a rate hike

. The idea is to counter inflation, particularly in the face of a surge in interest rates in certain countries in the euro zone, but in the face of the ambient panic, the ECB had to work to reassure investors.

What is the rate situation?

The announcement on 9 June by the ECB of

a quicker-than-expected tightening of monetary conditions

in the euro zone to curb inflation has violently shaken the bond market, where the debt already issued is exchanged. The ECB’s asset purchases will stop on July 1, 2022 and a rise in key rates (0.25 percentage points) is expected the same month, a first since 2011.

Evolution of European Central Bank (ECB) interest rates since 2008 (AFP / )

Evolution of European Central Bank (ECB) interest rates since 2008 (AFP / )

As a result, the interest rates of the most indebted countries rose much more than the German benchmark rate (the Bund), a sign of investor mistrust.

This rate difference, called “spread”, has widened dramatically

after the message from the ECB last Thursday which led experts to anticipate a total increase of around 1.50 percentage points, by the end of 2022.

The ten-year Italian rate exceeded 4% on Monday, a level not seen for 8 years, when it was still at 0.50% in the summer of 2021.

The spread with the Bund widened to 2.50 percentage points

. In the current context, “a rise in rates and spreads is normal but there is an irrational aspect” on which the ECB can precisely play, underlines Gilles Moëc, chief economist of Axa Investment Managers.

Is there danger in the house?

The current level of “spread” between Germany and Italy is resurfacing

a risk of distrust of Italian debt

and the threat of a recurrence of a debt crisis in the euro zone after that of 2011/2012. During this crisis, about 5 percentage points separated the German rate and the Italian rate, which is double the current level. In 2021, this gap averaged 1.35 percentage points.

“Financial conditions in Italy are deteriorating much faster than elsewhere in the euro zone”,

the country with sluggish growth

, notes with AFP Franck Dixmier, director of bond management at Allianz Global Investors. So quickly that it “calls into question the plans of the Italian government three months ago”, adds Gilles Moëc.

What signals sent by the ECB?

The ECB has decided to hold an exceptional meeting on Wednesday. The last time it had met unscheduled was in 2020 to set up the emergency program against the pandemic. Wednesday,

the ECB wanted to show its determination to take the bull by the horns

and to avoid causing rates to slip in the euro zone and creating panic on the Italian debt.

At the end of this meeting, the Frankfurt institution confirmed that a new “anti-fragmentation” instrument would be designed and instructed its teams to “accelerate” its development.

She also promised to apply “a certain flexibility in the reinvestment”

bonds held under its emergency program launched during the pandemic (PEPP).

Concretely “this means that while waiting for the specific tool, the ECB will use the reinvestments of the PEPP, perhaps by buying Italian debt”, details Franck Dixmier.

For the rest of the content of this specific tool

, it’s the big blur for the moment but its announcement is nevertheless welcome, according to the expert from Allianz GI. Moreover, bond rates have largely calmed down in the wake of the ECB’s announcements.

“It is a necessary and sufficient condition for the ECB to be totally free in the conduct of its monetary policy, that it is not handicapped or hampered in its rate hikes”, explains Franck Dixmier. Also, know that ”

the ECB aims to fight inflation

but that it takes into account what is happening on the financial market and in particular borrowing rates” largely reassured the market, according to Ilana Azuelos-Bossard, deputy director at Kiplink Finance.


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