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The European Central Bank (ECB) will take needed steps to ensure that the Eurozone avoids a debt crisis similar to the one during the Great Recession, ECB president Christine Lagarde said last week.
In 2008, in several European countries, property bubbles burst, banking systems collapsed, governments flooded stimulus money into economies to save them, and the International Monetary Fund placed several countries under austerity measures.
A key indicator of the crisis then was a widening spread between borrowing rates of different countries.
The spread between German and Italian interest rates grew to 2.17 points, the most in almost two years, after the ECB recently indicated it would raise its key interest rate next month.
The ECB will prevent such “fragmentation” in borrowing costs among Eurozone nations, Lagarde vowed, but gave no details about the steps the bank would take to do so.
“We know how to design and deploy new instruments, if and when necessary,” Lagarde said in a press briefing. “We have demonstrated that in the past. We will do so again.”
The bank could narrow the rate spread by reinvesting the proceeds of its €1.7-trillion bond-buying program begun during the COVID War. The ECB bought bonds during the COVID War at artificially low interest rates to keep borrowing costs relatively uniform among member nations.
There are no trigger points to begin a new bond-buying program now, Lagarde said.
“There is no specific level of yield increases or lending rates or bond spreads that can unconditionally trigger this or that,” she said.
As a result, Italy faces the “unpalatable combination” of the ECB’s rising interest rate with no indication of how high sovereign bond yields might go, Rabobank strategist Richard McGuire told the Financial Times.
“We do not know where the pain point is,” creating “an invitation for pressure to build,” he added.
The bank recently indicated it would probably stop buying new bonds after it raised its interest rate.
Asked when the purchases would stop, Lagarde said that decision will be left to a future ECB meeting.
However, the ECB will continue reinvesting its bond proceeds “for an extended period of time past the date when it starts raising the key interest rates and, in any case, for as long as necessary to maintain ample liquidity and an appropriate monetary policy stance,” she said.
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Lagarde and the ECB said they would wield their tools to tame inflation down to the bank’s 2-percent target.
However, they have done nothing.
Given that record, it is hard to believe that the central bank will act aggressively to even out bond spreads.
Also, launching a new bond-buying scheme while raising interest rates would face hard opposition from ECB debt hawks Germany and Denmark.