Et is a somewhat awkward word that is now used conspicuously often in the speeches and papers of the European Central Bank (ECB): it is called “fragmentation”. Translated, it means something like disordered splitting. What is meant by the central bank is the concern that with the forthcoming interest rate hikes, the first in eleven years, the euro area could financially split into several parts if the yields on government bonds from highly indebted countries, especially from southern Europe, should rise rapidly and the gaps widen with it to the yield on German government bonds. Recently there has been a rampant fear that something like the euro crisis could start again. After all, the yields on Italian government bonds, for example, had already risen to more than 4 percent since the ECB presented its plans for interest rate hikes in more concrete terms last week.
New monetary policy instrument of the ECB
The ECB’s answer to this also bears the more cumbersome name “anti-fragmentation instrument”. What is meant is a monetary policy instrument with which the central bank is able to prevent bond yields and thus the interest rates of individual euro countries for their national debt from getting out of control, even in times of rising interest rates. The details are not yet publicly known, but in principle such an instrument can only work if the central bank buys bonds from the countries concerned. ECB President Christine Lagarde presented the relevant plans to euro area finance ministers on Thursday, saying that the new instrument will be used if borrowing costs for weaker countries rise too much or too quickly. Earlier on Wednesday, the Governing Council of the ECB agreed at an emergency meeting that corresponding plans for a new instrument should be pursued with greater urgency. Until then, the ECB wants to flexibly invest the money from maturing bonds from its expiring bond purchase program, probably in favor of the indebted countries in the event of turbulence.
A certain calming down was observed on the market for European government bonds. Yields in southern European countries fell sharply on Wednesday. In the bond markets it was said that it doesn’t matter what this new ECB instrument looks like – what matters is the signal that the ECB will not accept every increase in bond yields. Yields rose again at times on Thursday, albeit not to the old level. On Friday, however, there was a certain relaxation.
“The markets now know that the ECB would intervene before a crisis has completely got out of hand,” said Holger Schmieding, chief economist at Bankhaus Berenberg. The financial markets had hoped for the announcement of an anti-fragmentation instrument and have now acknowledged it with short-term lower bond yields, said Michael Heise from the fund company HQ Trust: “But the announcement will only have a temporary and fleeting effect on returns.”
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