The European Central Bank is using its pandemic-era bond-buying program to shield highly indebted eurozone countries from the effects of its decision to cancel stimulus programs in its bid to combat the inflation.
The central bank made net purchases under its pandemic emergency purchase program in March, but is focusing reinvestments of maturing bonds on the bloc’s most financially fragile members.
Between June and July, the ECB injected 17 billion euros into the Italian, Spanish and Greek markets, while letting its portfolio of German, Dutch and French debt fall by 18 billion euros, according to Financial Times calculations based on central bank data.
“The gap is now very large,” Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said of the ECB’s reinvestments. “It seems that the ECB has been very active in reinvesting almost all of the revenue from the central countries in the peripheral countries.”
The reinvestments underscore the ECB’s eagerness to limit borrowing costs for countries like Italy and prevent a eurozone debt meltdown as it steps back from the accommodative monetary policy that has supported the bloc since the debt crisis ten years ago.
It comes after the ECB last month raised interest rates for the first time since 2011 after taking the decision to wrap up the PEPP program, and a longer-duration bond-buying program called the PEPP program. purchase of assets.
Sven Jari Stehn, chief economist for Europe at Goldman Sachs, said the “extent of flexibility that was used” to reinvest proceeds from the bonds that were part of the PEPP program was “a bit more than what at what people expected.
ECB policymakers and investors fear that the tightening of monetary policy will widen the gap between the strongest and weakest economies in the region – the so-called risk of fragmentation. These fears widened the spread between Italian and German benchmark 10-year bond yields to 2.4 percentage points in June, a level last seen during the market tumult at the start of the pandemic in 2020. .
The spread has since narrowed to around 2.1 percentage points after the ECB pledged to tackle fragmentation. Last month, the ECB said flexibility in rolling out PEPP reinvestments would be the “first line of defense” in its bid to limit so-called spreads.
“I think it’s a good thing for them to be bold. . . it’s good for the markets to see that they are putting their money where they say,” Ducrozet said, adding that “the clear message is that they are using this flexibility almost to the maximum that they can.”
The central bank also introduced a new transmission protection instrument last month that can be used in the event that PEPP reinvestments fail to control spreads. The tool allows the ECB to buy the bonds of any country it deems facing market pressure outside of the economic outlook, on an unlimited scale. Investors watched Italian spreads cautiously to see when the ECB might step in, with many considering 2.5 percentage points a significant mark.
While the ECB has yet to use the new tool, its use of PEPP reinvestments shows how keen policymakers are to keep spreads in check.
Jari Stehn said it was “an activation of the first line of defense against the risk of fragmentation, but it still means that the question remains open as to whether and when the TPI is activated”.