A European Central Bank poised to raise interest rates for the first time in 11 years vowed Wednesday to create an unspecified market backstop that could buffer member countries against financial turmoil like that seen during a debt crisis more than a decade ago.
Pressed by a government bond selloff, the bank’s governing council called an unscheduled meeting to address worrisome market shifts following the bank’s decision to hike rates in July and September.
ECB bond purchases and record low interest rates have kept borrowing costs low for businesses and governments. But those measures are coming to an end as the bank pivots to deal with record inflation of 8.1% in the 19 European Union countries using the euro currency.
The bank last week announced it will raise rates to cool rising prices but did not offer a specific measure to halt market turbulence caused by suddenly higher borrowing costs for more indebted EU countries, such as Italy and Spain.
Instead, the central bank simply said it would act if needed against “fragmentation,” or excessively high borrowing costs plaguing one part of the eurozone and not another. That is one complication of having one currency and central bank for 19 countries.
The unspecific pledge to act wasn’t enough to satisfy government bond markets, and the “spread,” or difference between what Italy pays for borrowing and what financially solid Germany pays, began to increase.
Those so-called spreads are a key fear index for the eurozone. Spreads widen when investors sell off Italian bonds, lowering their price and raising interest yields, which move opposite from price. Rising yields can reflect investor views that a country’s bonds carry more risk of loss.
The ECB said it would speed development of “a new anti-fragmentation instrument” that could be reviewed for approval by the governing council. Its statement didn’t say what that instrument would be.
The bank also said it could use money it gets from maturing bonds it holds to make new purchases and fight excessive borrowing costs if individual countries face market pressure.
The ECB already has an emergency bond-market backstop that could allow it to step in and buy the debt of a troubled country. That tool helped calm the 2010-2012 debt crisis after the bank announced it as part of then-President Mario Draghi’s promise to do “whatever it takes” to keep the eurozone from breaking up.
But that program, which never actually had to be used, can come with tough conditions for reform and governments may be reluctant to turn to it.
Holger Schmieding, chief economist at Berenberg bank, said the “situation today is different from the euro crisis a little more than a decade ago” because countries have improved growth prospects and the ECB has the bond-market backstop in its back pocket if needed. Current conditions “should not present an…