European Central Bank to create new tool to address fragmentation risk after bond yields surge

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

John Thys | Afp | Getty Images

The European Central Bank announced Wednesday that it plans to create a new tool to tackle the risk of euro zone fragmentation, in a move designed to assuage fears of a fresh debt crisis.

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

“Since the gradual process of policy normalization was initiated in December 2021, the Governing Council has pledged to act against resurgent fragmentation risks,” the ECB said in a statement.

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

The comments reflect the recent surge in bond yields over the past week or so. After a regular policy meeting last week, the ECB suggested a more aggressive policy tightening but failed to deliver any new measures to support highly indebted nations in the bloc.

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

Italy’s 10-year bond yield crossed the 4% mark earlier this week — with one economist saying these levels “could eventually turn into a problem” for the south European nation.

To tackle these concerns, the ECB said Wednesday that it will reinvest redemptions from its emergency bond purchasing program — referred to as PEPP — in a flexible way and it will 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 stepping in when needed backs up this commitment.”

Euro zone bond yields fell on Wednesday morning following the surprise announcement of an emergency meeting.

The euro, meanwhile, traded higher against the U.S. dollar on expectations that the ECB could introduce measures designed to avoid fragmentation.

This is breaking news. Please check back for updates.

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