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The European Central Bank will create a new tool for managing fragmentation risk

Christine Lagarde, President of the European Central Bank. The central bank is planning an emergency meeting to raise higher bond yields.

John Thys | Afp | Getty pictures

The European Central Bank announced on Wednesday that it plans to create a new tool to tackle the risk of fragmentation of the eurozone, in a move designed to allay fears of a new debt crisis.

The decision comes after the central bank surprised market participants with an urgent meeting to raise higher borrowing costs for many European governments.

“Since the gradual process of policy normalization was initiated in December 2021[ads1], the Governing Council has promised to act against the resurgence of fragmentation,” the ECB said in a statement.

“The pandemic has left lasting vulnerabilities in the euro area economy that are actually contributing to the uneven transfer of the normalization of our monetary policy across jurisdictions,” it added.

The comments reflect the recent rise in bond yields in the last week or so. Following a regular policy meeting last week, the ECB proposed a more aggressive policy tightening, but failed to deliver any new measures to support high-debt nations in the bloc.

This triggered some nervousness among money managers about financial fragmentation and led to an increase in bond yields.

Italy’s 10-year bond yields passed the 4% mark earlier this week – with an economist saying these levels “could eventually become a problem” for the southern European nation.

To address these concerns, the ECB said on Wednesday that it would reinvest redemptions from its emergency bond buying program – referred to as PEPP – in a flexible manner, and would ask its team to “accelerate the completion of the design of a new anti-fragmentation instrument.”

Isabel Schnabel, a member of the ECB’s Executive Board, said in Paris, France on Tuesday: “Our commitment to the euro is our anti-fragmentation tool. This commitment has no limits. And our track record of going in when needed supports this. Commitment. “

European countries faced significantly high borrowing costs in the wake of the sovereign debt crisis, back in 2011. Some of the imbalances have been resolved, but there are still concerns for the region as a whole, especially because it has one monetary policy for 19 different fiscal policy areas. positions.

Market reaction

The yield on the 10-year Italian bond fell further following the ECB’s announcement of trading below the 4% mark.

Borrowing costs for other eurozone governments also fell on the news, with Greece’s 10-year bond yields trading more than 7% lower.

In the foreign exchange markets, the euro traded higher against the US dollar and continued the trend seen earlier in the session when the news came that there would be an emergency meeting.

Shares in Italian banks, which had risen earlier on Wednesday, continued to trade higher after the monetary policy decision.

Mario Centeno, a member of the ECB’s Governing Council, said that faster normalization of monetary policy is a risk that can not be ruled out, according to Reuters. The central banker added that the pace of interest rate increases would be “gradual”.

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