Bond turbulence prompts ECB reaction but questions remain

Economy

It took an extraordinary meeting by the ECB’s board to ease some of the recent pressure on Greek bonds (GGBs). The eurozone’s central bank said in the statement following an extraordinary meeting this week that it will take steps to avoid fragmentation in the monetary policy transmission across different countries.

The ECB also reiterated that PEPP reinvestments can be flexible enough to be directed towards countries whose yields might require containment and pledged the design of a new instrument to control spreads in the eurozone.

After last week’s regular meeting, when the ECB announced a path for interest rate rises from July that would reach 75 points by September and confirmed that regular QE would end in July, GGBs, along with other periphery bonds, were put under pressure. Yields reached 4.72 pct mid-week, from 3.83 pct just a week earlier.

As of Friday, the 10-year benchmark was 4.28 pct. The turbulence in the sovereign debt market does not pose an immediate fiscal concern for Greece thanks to a combination of factors, as we outlined this week. Nevertheless, Greece’s debt strategy has been put on hold and prolonging the current unsettled market conditions would essentially place Greece out of the markets unless pressure eases off to more reasonable levels.

Although hopes are pinned on the ECB providing a solution, we understand that expectations should be modest as the overall view of more conservative nations was not changed within a week and any instrument will probably have to be moderate and potentially could come with conditionality attached. 

With the Fed announcing this week a rate hike of 75 basis points, the highest since 1994, it is beyond question that monetary policy is in a normalisation phase as central banks are looking to tame inflation. 

However, given that the eurozone has used during the pandemic most of the ammunition available via fiscal policy, tightening monetary policy risks pushing economies into recession. It is already reported that banks have started reflecting the new conditions on loans to households and firms, pushing up the cost of borrowing.

In this tumultuous environment, the Greek authorities welcomed the positive mood at Thursday’s Eurogroup, where Greece was essentially waved through the enhanced surveillance finish line, subject to completing a list of 22 outstanding reforms by the end of the year. The Eurogroup also approved the release of 748 million euros of debt relief. The final disbursement will come once the reforms are delivered later in the year.

After 12 years during which there were three adjustment programmes and an ensuing enhanced surveillance scheme, European officials must be pleased to see the conclusion of this style of relationship with a member state. According to reports, though, some countries still see Greece as a special case, despite the PM noting that the country is no longer the black sheep of Europe, and will no longer have its policies dictated by others.

That said, Greece will have to walk a very narrow fiscal path with the country expected to deliver primary surpluses of more than 2 pct of GDP from next year and for a period of four decades, although with some policy flexibility within the SGP boundaries.

A report by the ESM published this week also reminded the Greek authorities that the country is still facing several challenges, with reforms required in the public sector and the judiciary, while imbalances persist as a result of high debt levels, the investment gap, low productivity and still high levels of bad loans.