Everything could be upside down, with debt soaring and risk premiums in the stratosphere. But peace reigns in the European debt markets. When last June, Christine Lagarde published in Amsterdam the roadmap of the European Central Bank (ECB) with the end of the bond purchase program that same month and the announcement of the first increase in interest rates in eleven years , the markets once again shook the foundations of the eurozone.
Especially for Italy. Immediately, the Italian 10-year bond climbed to 4.3% and the risk premium of this country shot up to 250 points. In the case of Spain, the increase in the yield on debt and the risk premium were more moderate, but also significant.
The alarms went off and the Eurotower reacted quickly. A few days later, the ECB held an extraordinary meeting by surprise in Frankfurt in which it addressed the crisis that had just begun. In a statement, the institution explained that the governing council had decided to “apply flexibility in the reinvestment of reimbursements due in the PEPP portfolio [the bond purchase program due to the pandemic crisis] with a view to preserving the functioning of the monetary policy transmission mechanism”.
Everyone understood that the ECB would not allow a new debt crisis. And the warning stuck. Instantly, risk premiums fell back and have remained under control in the following months despite the macroeconomic scenario that hangs over the eurozone –rampant inflation, energy crisis, lurking recession– and the rise in interest rates since 0% to 2% in the last three months. Neither the fall of Mario Draghi's government nor the coming to power of Giorgia Meloni have changed things.
Christine Lagarde's ECB has achieved what seemed impossible. His particular whatever it takes – Draghi's phrase, his predecessor, who saved the euro in 2012 – has been Lagarde's dialectic and a weapon, the Transmission Protection Instrument (TPI), which it hasn't even been used. The ICC should allow the ECB to act in the bond market in certain circumstances of unjustified stress on a country's sovereign debt. Created last July and with limitations to prevent it from being a form of indirect financing for members of the euro, it is yet to be launched.
But it works now. “It is the nuclear button of the ECB, with dissuasive effects on speculators in the face of the mere possibility that Lagarde presses it,” sources from the central bank environment explain. Along with the dissuasive effect of the TPI, the ECB introduced a modification in June to provide itself with greater flexibility in reinvesting the maturities of the PEPP, the pandemic emergency purchase program. And all this has been enough.
The result is obvious to the eye. In the last six months, the ten-year German bond has increased its yield (yield) 130 points (1.3%) to 2.3%, while the Italian has risen 150 points (1.5%) to 4 .4% and the Spanish has done the same with about 140 points to 3.4%. All the yields are higher, as befits an environment in which rates are rising a lot, but it is striking that the spreads are swimming in a raft of oil: 110 points, the Spanish risk premium, and almost 220 points, the Italian . More or less as they were...
The current bonanza is partly due to the fact that the growth of Italy and Spain, supported by the increase in tax collection due to inflation, is much higher than the higher cost of debt. This means that, at least for now, neither one country nor another has suffered from the rate hike. Is everything done? Not much less. The good arts of the ECB have yet to pass important tests.
In October, the year-on-year inflation rate in Italy and Germany – the third and largest economy in the euro – shot up to 12.8% and 11.6%, respectively. In parallel, their economies are slowing down by leaps and bounds. There is talk of a technical recession, perhaps two or three quarters, but no one knows for sure what 2023 will look like.
In Frankfurt, meanwhile, they remember that they prioritize price stability over everything else. "We have to do what we have to do," Lagarde hammered on October 28 after announcing the third rate hike in three months and warning of more hikes. The situation will soon demand the best version of Lagarde and the ECB. There are many curves.
