Basic ECB interest rates: Italy worries again – the economy

For many days on the world financial markets you can feel the whiff of “whatever you need”. The background to this is the European Central Bank’s July decision to raise its key interest rate for the first time in eleven years. The speculators got down to business right now, as higher interest rates mean higher refinancing costs. Can financially weaker countries in the euro area, such as Italy, afford it?

Loans have become more expensive. Italy’s finance minister now has to pay over four percent to find buyers for ten-year government bonds – that was the case in 2014. For comparison: in May it was 2.8 percent. Also in Greece and Portugal, the yields increased sharply.

While Germany also has to pay more for loans, growth has been slower. At such moments, there is an immediate fear of a repeat of the euro debt crisis of 2011/2012. With the 2012 “everything it takes” promise, former ECB president Mario Draghi launched the lifeline for the euro area. Promise: in an emergency, the central bank will buy government bonds from member states to secure their refinancing. Is it soon?

ECB president Christine Lagarde was reluctant to get involved after last week’s interest rate decision. She promised that the ECB would respond in the event of increased “fragmentation”. Central bankers use the term to describe a situation where interest costs for individual euro area countries are rising much more than in Germany. Experts talk about the “spread” or the difference in interest rates. “We will ensure there is no fragmentation in the eurozone,” said Lagarde, referring to the existing pool of 1.7 trillion euros that would be available for emergency bond purchases – reduced by buying ECB bills of interest rate index. The amount corresponds to the volume of bonds purchased during the Corona pandemic. When one of these bills mature, the ECB reinvests that amount. The money should be invested mainly in Italian bonds. Lagarde stressed that there is no predetermined interest rate differential at which the central bank will intervene. You want to leave the markets in the dark.

But stock investors like uncertainty. There the question is asked: where is the great bazooka? Draghi’s promise of “whatever happened” was never kept, and since 2012 the words of the former ECB chief have been reassuring to the market. Meanwhile, this rescue program with technical term OMT (Unconditional money transactions, for example in German: outright monetary policy transactions) as impracticable. The background is the clause: euro area countries that would be central bank backed through OMT would first need to agree on a loan program with a euro rescue package, which is accompanied by economic policy conditions. It is hard to imagine a euro area country accepting this gag. Certainly not Italy.

How is the central bank going to catch speculators when they start betting against Italy again?

So how is the central bank supposed to catch the financial markets if speculators suddenly bet the currency union again? Is 1.7 trillion euro available enough? What would be the alternative? Following the decision on interest rates, the ECB chief Lagarde said that existing or new instruments would be used in an emergency to prevent “fragmentation”. But the Governing Council does not want to be more specific. The reason: this openness could encourage investors to test the central bank and its bailout program. So the currency keepers will likely wait in detail until the worst becomes the worst.

The central bank is in trouble. 8.1% the inflation rate in the euro area is at the highest ever in its more than 20-year history. In Germany, too, expensive refueling and higher prices for staple foods such as bread and oil have driven inflation to its highest level in almost 50 years at 7.9 percent. The ECB itself predicts that next year prices will rise by more than two percent, and a year later – this is the ECB’s target. Therefore, the pressure for further interest rate increases is not declining. At the same time, high interest rates are dangerous to economic development. Some experts are expecting a recession – and there is also fear of another debt crisis in the eurozone.

In this situation, communication in which you are completely relaxed can help. “The fact is that Italian yields have increased more than others, more than Germany,” said Gediminas Šimkus, member of the ECB’s Governing Council. “Does that worry me? From what I saw, no, added the president of the Lithuanian central bank.

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