Rising spreads between euro area countries causing concern

Uncomfortable realities behind ECB’s dilemma over fragmentation and inflation

ECB to design new anti-fragmentation instrument

What is the appropriate spread between German and Italian government debt? The obvious answer is ‘what the market determines’, but the European Central Bank is clearly unhappy with that result.

The return of inflation and a backdrop of rising rates have led to a rapid widening of European government bond spreads. The 10-year BTP is around 200 basis points wide of the Bund — a mark last hit during the first wave of Covid-19 in Europe in early 2020.

It is worth spending a moment to reflect on why this is a problem. Debt sustainability is the first concern but the relevant factor there is the absolute yield (or, more precisely, debt servicing cost versus cashflow), not the spread. If Italy is forced to pay 7% for its 10-year paper (as was briefly the case during the sovereign debt crisis), then debt sustainability will be a concern regardless of what Germany pays.

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-Behind the scenes, spectre of losses for central banks – and for taxpayers

The European Central Bank’s complex planning for an anti-fragmentation facility for euro area unity could backfire – by exposing rather than alleviating long-standing sources of fracture.

The ECB’s uneven communications over efforts to limit renewed bond market flare-ups and harmonise its ‘monetary transmission’ demonstrate an uncomfortable dilemma. The ECB and national central banks have been deliberating internally for at least three months a necessary fragmentation-prevention tool to accompany slow normalisation of European interest rates in response to rocketing inflation partly caused by the Russian invasion of Ukraine.

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Πηγή: omfif.org

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