ECB pledges new crisis tool to help indebted southern states

Summary

• Will focus reinvestments on high-debt members
• To devise new tool
• Markets disappointed
• Lagarde to speak at 1620 GMT

The European Central Bank promised fresh support on Wednesday to temper a market rout that has fanned fears of a new debt crisis on the euro area's southern rim but appears to have disappointed investors looking for bolder steps.

Government borrowing costs have soared on the 19-country currency bloc's periphery since the ECB unveiled plans last Thursday to raise interest rates to tame painfully high inflation that is at risk of becoming entrenched.

The sell-off was then exacerbated by the ECB's vague commitment to limit the rise in borrowing costs, raising fears that policymakers were abandoning more indebted nations, such as Italy, Spain and Greece.

Keen to avoid the repeat of the debt crisis that almost brought down the single currency a decade ago, the ECB reversed course just six days later, unveiling plans for a new support scheme and directing cash from debt maturing in a recently-ended 1.7 trillion euro ($1.8 trillion) pandemic support scheme towards indebted nations.

"The Governing Council decided to mandate the relevant Eurosystem Committees together with the ECB services to accelerate the completion of the design of a new anti-fragmentation instrument for consideration by the Governing Council," the ECB said after an extraordinary meeting.

Speaking at a conference on Wednesday, Dutch central bank chief Klaas Knot said that policymakers instructed staff to work at an accelerated pace on the new tool, in case sending reinvestments south were not enough.

"If it will not be enough, rest assured that we stand ready," Knot said.

His Slovak counterpart, Peter Kazimir said it was still "premature" to discuss the details of what a new tool would look like.

Bare minimum?
Investors welcomed the ECB's intentions but were still disappointed by the dearth of detail and the lack of a firm commitment.

"I think essentially it is the bare minimum of what could be expected, but I also believe it's the most realistic outcome of what they could compromise today," Danske Bank economist Piet Christiansen said.

He added that asking staff to devise a plan also bought policymakers some time to see how the market would settle on its own.

But the announcement also drew fire from those who argued the ECB risked going too far.

"The ECB's job is to deliver on price stability, not to ensure favourable financing conditions," Markus Ferber, a member of the European Parliament said. "Some countries now simply get the bill for years of irresponsible fiscal policies."

"If the ECB now launches yet another programme to keep spreads low, it edges dangerously close (to) monetary state financing," Ferber said.

The euro fell around 0.5% against the dollar after the ECB statement but Italian yields eased around 2 basis points following a brief surge.

The spread between 10-year Italian and German bonds, a key indicator, meanwhile widened to 241 basis points in the immediate aftermath of the announcement but then returned to 226 basis points, indicating confidence that the ECB will act more firmly, perhaps at the 21 July policy meeting, when it is all but certain to raise rates for the first time in over a decade.

The ECB's move comes on the same day that the US Federal Reserve is expected to hike interest rates, with investors dramatically raising their bets for a 75 basis point increase, a swing in expectations that has fuelled a violent sell-off across world markets.

Italian spreads peaked at around 250 basis points on Tuesday, their highest since early 2014 raising worries that Italy's high debt level could become unsustainable.

There is no universally accepted level for this spread, but Carlo Messina, the CEO of Intesa, Italy's largest bank, earlier on Wednesday said the country's economic fundamentals would justify 100 to 150 basis points.

The spread on 10-year Spanish bonds meanwhile widened to 128 basis points after the ECB's announcement from around 125, while for Greece, it rose to 269 basis points from around 260.

ECB President Christine Lagarde is due to speak at 1620 GMT in London in an engagement scheduled earlier.

($1 = 0.9542 euros)