ECB arrests bond yield growth

The new anti-fragmentation program of the European Central Bank will reduce the rising borrowing costs of vulnerable countries in the eurozone, such as Greece, while keeping the pressure on governments to pursue prudent fiscal policy, as it will contain relevant conditions, according to ECB head Christine Lagarde. Plans on flexibility might concern the purchase of new state bonds before the maturity of older ones.

The French official said in a speech at the annual conference of the European Central Bank in Portugal, “The new instrument will have to be effective, while being proportionate and containing sufficient safeguards to preserve the impetus of member-states towards a sound fiscal policy.”

Lagarde’s comments suggest the new tool may be linked to terms and conditions for countries that benefit from it. Although no final decision has been made on the program, Kathimerini understands it will include light conditions, such as countries’ compliance with the annual financial recommendations of the Commission or with the implementation of the reforms of the Recovery Fund as opposed to any strict criteria. According to Belgian central banker Pierre Wunsch, the ECB should only activate it in countries with sound fiscal plans.

Lagarde pointed out that monetary policy normalization will lead to an increase in interest rates and government bond yields, and, as eurozone countries start from different fiscal positions, it could also lead to an increase in spreads. She explained that in order to maintain the smooth transmission of policy stance across the euro area, it must be ensured that revaluation is not exacerbated or distorted by destabilizing market dynamics, leading to the fragmentation of the initial policy impetus.

The head of the ECB also announced that on Friday, July 1, the lender’s first weapon against fragmentation, that of PEPP’s flexible reinvestments, will be activated. Sources have told Kathimerini that the flexibility – in addition to time, asset categories and countries – may also concern the forward-looking securities market – i.e. the ECB buying new bonds before the older ones mature. It is noted that the maturities of PEPP bonds in the whole of 2022 amount to approximately 185 billion euros.