Germany’s finance minister challenged the European Central Bank on the specter of bond market fragmentation in the euro zone, saying he saw no particular risks in current market conditions.
Christian Lindner told the ECB President in a closed session that he was not concerned about recent moves in bond yield spreads in the eurozone, and that talk of fragmentation in the bloc’s financial markets could damage trust, according to people familiar with the discussion.
His words came after the ECB held an emergency meeting on Wednesday in which its governing council pledged to speed up plans to create a ‘new anti-fragmentation instrument’ – a reference to the widening gap in the cost of borrowing between more stable sovereigns like Germany. and more vulnerable Member States such as Italy.
The unscheduled ECB meeting came after bond yields in countries including Italy and Spain rose to their highest level in eight years following a move by ECB rate setters last Thursday to stop buying more bonds and start raising interest rates.
Eurozone finance ministers discussed the situation with ECB President Christine Lagarde during a meeting in Luxembourg on Thursday. Not all politicians seemed convinced the recent moves were untoward, and Lindner suggested the ECB’s hastily called meeting risked stoking market nerves.
Speaking ahead of the meetings, Lindner said the eurozone was “stable and robust” and he did not share concerns about fragmentation in the region. While the gaps were increasing in some Member States, their current levels indicated “there is no cause for concern”.
“Our task as finance ministers is to show that we are returning to sustainable public finances and that we are leaving the expansionary budgetary policy of the [coronavirus] pandemic behind,” he said, emphasizing the importance of fighting inflation. The German finance ministry did not respond to requests for comment.
Sigrid Kaag, the Dutch finance minister, said after the meetings in Luxembourg that it was important to “project confidence and calm” and not to “express oneself prematurely” by monitoring what was happening in the markets.
Lagarde defended the ECB’s handling of the situation at the meeting, telling ministers, ‘we have to deal with the risk of fragmentation to enable the implementation of monetary policy across the euro area,’ according to people familiar with discussions.
She added: “The risk of fragmentation is a serious threat to our price stability mandate. To doubt our commitment would be a serious mistake.
Eurogroup chairman Paschal Donohoe later said the recent moves in financial markets were a response to the ECB’s “understandable” decision to begin monetary policy normalization.
Ministers, he added, were “absolutely united” in their view that the eurozone would continue to be “very robust, would continue to be resilient, even if these market conditions change as they are”.
Lagarde spoke tough on inflation last week as he unveiled a plan to end eight years of negative interest rates and bond buying. But a few days later, the ECB called an emergency meeting and said it would speed up work on a new policy tool to tackle turmoil in bond markets.
The central bank gave few details on how the new instrument might work, although most experts expect it to involve targeted purchases of bonds from eurozone countries suffering from a rise. unjustified in their borrowing costs relative to others. Analysts expect the ECB to unveil the tool at its July 21 meeting.
Italy’s central bank governor Ignazio Visco said Thursday his emergency meeting was not a sign of a panic. But he also said any increase in Italy’s spread above 2 percentage points created “very serious problems” for the uniform transmission of monetary policy.
The ECB fears that a panic in the bond market could drive the borrowing costs of weaker countries to a level that pushes them into a financial crisis and prevents the central bank from bringing inflation back from its record level of 8 .1% to its target of 2%. .
One explanation of what the ECB is trying to achieve came from board member Isabel Schnabel, who said in a speech shortly before Wednesday’s meeting that “there is no reason to assume that the sovereign bond yields are identical.
“There are, however, times when yields quickly deviate from economic fundamentals, causing financial instability and therefore fragmentation,” which Schnabel defined as “a sudden breakdown in the relationship between sovereign yields and fundamentals, giving give rise to non-linear and destabilizing dynamics”. .
Ministers attending the Eurogroup meeting in Luxembourg separately agreed that they should work to strengthen the region’s common framework for managing banking crises and national deposit guarantee schemes.
They did not, however, approve a detailed work plan to complete the proposed EU banking union, as had been suggested. Instead, they agreed to review the project later, with a view to identifying “possible alternative measures” addressing outstanding elements of the plan.