Investors say the European Central Bank must ramp up its bond purchases if it wants to arrest one of the sharpest rises in borrowing costs for Italy and other eurozone members since the region’s debt crisis nine years ago.
Italy’s 10-year bond yield surged above 2.1 per cent on Monday, up nearly 0.4 percentage points, as remarks made by ECB president Christine Lagarde last week continue to ricochet through debt markets. Italian spreads above German bonds — seen as a key measure of country risk in the eurozone — hit their highest level since last June.
Spreads also widened to the most in more than a year in Spain and Portugal, as the sell-off rippled through eurozone bond markets, although borrowing costs remained well below the heights scaled during the 2011 crisis.
“Italy, and other eurozone members, needs to be able to deploy a fiscal response to the crisis at a cheap price,” said Ludovic Colin, a portfolio manager at Vontobel Asset Management. “The ECB can’t let this go further.”
Ms Lagarde has come under criticism since saying at last Thursday’s ECB press conference that it is not the central bank’s job to “close the spread” in bond markets. She later tried to walk back the comment in a TV interview and apologised to her fellow governing council members on Friday, two people involved in the call told the Financial Times.
But investors say the damage has been done, and only a decisive intervention in markets will demonstrate that Ms Lagarde retains the commitment of her predecessor Mario Draghi to hold down eurozone borrowing costs.
“It’s all well and good saying ‘sorry,’ but if they want to see some impact they’ll have to put their money where their mouth is,” said Mark Dowding, chief investment officer at BlueBay Asset Management.
The ECB last week announced a €120bn expansion of its asset purchase programme this year, on top of the €20bn a month already committed. That still leaves the monthly pace of purchases well short of the €80bn seen at the peak of the ECB’s quantitative easing programme, and pales next to the Federal Reserve’s $700bn of purchases announced on Sunday.
Some members of the ECB’s governing council indicated they would have preferred a bigger increase to the bank’s extra bond purchases at last week’s meeting.
Several members of the ECB’s top decision-making group have since said publicly that it could further increase its target for bond purchases, while emphasising that it has flexibility to front-load the extra purchases and to focus on a particular country’s bonds if necessary.
The ECB’s chief economist, Philip Lane, said the central bank was “ready to do more” to contain any government debt stress. Fabio Panetta, another ECB executive board member, said: “If necessary, we can further expand the programme.” Peter Vanden Houte, an economist at ING, predicted the ECB would have to increase its bond-buying programme by an extra €100bn.
“Last week’s ECB decision gave it more ammunition to combat the fallout from the coronavirus, but it will not be enough,” said Andrew Kenningham, chief Europe economist at Capital Economics. “We now think the bank will soon make an explicit commitment to keep sovereign bond yields low for all governments at least for the duration of the coronavirus crisis.”
If Ms Lagarde wants to convince investors that the bank has plenty of ammunition to contain any dislocation in sovereign debt markets, one option is to relax its self-imposed rule to buy no more than a third of any government’s eligible bonds, Mr Kenningham said.
However, the ECB believes it is not constrained in how many bonds it can buy, so there is no need to change those limits.
Italy has announced plans for a €25bn spending package to shield workers and small businesses from the worst of the pandemic, which economists expect to plunge the country into a deep recession and to push its already-large national debt towards 140 per cent of its gross domestic product.
Borrowing costs for the country, and for other former crisis hotspots, still sit far below their 2012 peaks. But if they rise much further, some investors could begin to question the sustainability of public finances, creating a self-reinforcing sell-off and over the long term, potentially reawakening questions about the make-up of the eurozone.
Mr Dowding said: “If they don’t show up with the big bazooka, Lagarde could end up responsible for killing the euro.”