The officials at the European Central Bank have to set one policy for many different countries, each with its own fiscal policy, economic outlook and debt level.
As the bank tightens its easy-money policies by raising rates and ending its multitrillion-euro bond-buying programs, it is also trying to prevent government borrowing costs from diverging wildly across the eurozone
On Thursday, the bank is expected to announce more details of a new policy tool it is designing to stop borrowing costs from rising out of sync with the economy.
The differences between countries are reflected in the yield on their bonds. Maybe because of a history of debt default or political instability, investors will demand higher yields from countries that they think are riskier to lend to.
The cost of borrowing for Italy, which has one of the highest debt burdens in the eurozone, has gone up since the European Central Bank decided to raise rates. The country's government fell apart this week after key parts of the coalition government abandoned the prime minister. The difference between Italian and German 10-year bond yields is double what it was a year ago.
A sudden break in the relationship between government borrowing costs and economic fundamentals is considered by the European Central Bank to be market fragmenting. It won't tolerate this because it will reduce the effectiveness of its other monetary policy tools.
Luis de Guindos, vice president of the bank, said earlier this month that it's critical that financing conditions move broadly in sync across the euro area. For two equally sound firms in the euro area, a change in the monetary policy stance should lead to a similar reaction in their financing conditions, regardless of where they are based.
At the end of June, the bank announced that it would implement its first line of defense against fragmentation by steering the reinvestments of proceeds from maturing bonds in its 1.85 trillion euro ($1.88 trillion) bond-buying program to bonds of countries that would best serve the economy. The proceeds from maturing German bonds could be used to purchase Italian debt.
The bank said it was working on a tool to stop borrowing costs in some countries diverging. Under the belief that the central bank would come to the rescue, disagreements need to be overcome about the design of this tool to make sure it doesn't encourage governments to be fiscally irresponsible.
This is not the first time the central bank has been through this. At the height of the eurozone's debt crisis a decade ago, the central bank tried to design a policy tool that would match the commitment by Mr. It was met with a lot of challenges.
The tool that would allow the bank to make unlimited purchases of a country's debt was never used.
The new tool is expected to have less conditions for a country to benefit from.
All Rights Reserved © 2024
