For a long time it had become quiet about the euro debt crisis. The ECB kept interest rates low with its bond purchase program. But now the nervousness of investors and the central bank itself is growing again.
Not only the stock exchanges are in turmoil. The bond markets are also in a state of flux. Yields rise in anticipation of rising interest rates. As a result, it tends to be more expensive for companies and states to borrow fresh money on the financial markets.
The heavily indebted euro states in particular are once again attracting the attention of investors. The interest premiums for government bonds from Italy and other countries are rising again. The Governing Council of the ECB met on Wednesday (June 15) for a special meeting called at short notice “to discuss the current market situation,” as a spokeswoman for the European Central Bank in Frankfurt said on request.
For years, the ECB kept interest rates low by buying up such government bonds through various programs. But now the ECB has announced a turnaround in its monetary policy: not only does it want to raise interest rates, it is also stopping its programs. No more new money should flow into the markets. Since the beginning of the year, premiums on Italian government bonds compared to Bunds have practically doubled. Things don’t look much better for Spain or Portugal.
The ECB throws this development into a dilemma. Officially, the bond purchase programs were never about helping the heavily indebted euro countries. The ECB justified it on the one hand by saying that inflation was too low and on the other hand that the “transmission” of its monetary policy was disrupted: effective monetary policy was not possible if interest rates differed too much, if there was “fragmentation”.
As long as inflation was low, the ECB could pump billions into the markets month after month with relative ease, buying bonds and thus keeping interest rate spreads in check. But now the inflation rate is almost eight percent and the ECB has announced several rate hikes. The big question now is: How can the ECB continue to keep the interest rate premiums of the debt-ridden states low and at the same time fight inflation with a tighter monetary policy?
ECB boss Christine Lagarde tries to spread confidence. “If necessary, we can develop new tools to ensure monetary transmission while we normalize monetary policy. We’ve shown that many times in the past,” she recently wrote in a widely acclaimed blog post.
However, details of such an instrument are not yet known. First of all, the ECB seems to be hoping to keep the spreads under control by reinvesting maturing government bonds. Because even if the ECB stops buying new bonds from July, there can still be no question of a reduction in holdings, as the US Federal Reserve is doing (“quantitative tightening”).
Experts can only guess what such an instrument could look like. Because the ECB has to achieve two incompatible goals: on the one hand, a restrictive monetary policy in order to lower the inflation rate, and on the other hand, printing money so that the surcharges don’t get out of hand. “If securities purchases (according to the theory of the ECB and other central banks) are inflationary, the ECB would have to raise interest rates all the more. Not only to fight the already rampant inflation, but also to compensate for the effect of asset purchases on inflation,” wrote Ulrich Leuchtmann, foreign exchange expert at Commerzbank, in a recent comment. “Of course, reality is not as simple as abstract theory would like it to be. An ECB, which has adhered to the theory of ‘transitory inflation’ for longer than all other major central banks, is not believed to be able to adequately compensate for the inflationary effect of securities purchases with even more interest rate hikes if the worst comes to the worst.
So if the rise in the southern euro countries continues, the moment could soon come when the ECB has to make a decision: does it risk a new euro debt crisis or does it want to continue fighting inflation decisively?
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