Lagarde defends ECB plan to counter bond market panic

The European Central Bank is determined to nip “in the bud” any fragmentation in borrowing costs between eurozone countries, its president Christine Lagarde said on Monday, warning anyone doubting this was “making a big mistake”.

Appearing before EU lawmakers in Brussels, Lagarde defended the ECB’s decision, made at an emergency meeting last week, to accelerate work on a new policy tool to counter a recent surge in the borrowing costs of more vulnerable countries. “You have to kill it in the bud,” the ECB president said.

Since the ECB voted earlier this month to begin removing some of its ultra-loose monetary policy, bond yields of weaker countries like Italy have soared faster than those for more stable countries like Germany.

Lagarde said that the ECB did not want to let that “fragmentation risk” happen and “hamper” the impact of its policy decisions. The ECB president told lawmakers: “You want to pre-empt that and you want to prevent it.”

Last week’s emergency meeting came after bond yields of countries such as Italy and Spain shot up to their highest level for eight years in the wake of a decision by ECB rate-setters six days earlier to stop buying more bonds and start raising interest rates.

The ECB worries that a bond market panic could push up borrowing costs of weaker countries to a level that drags them into a financial crisis. Such a crisis could limit the central bank’s capacity to use rate rises to bring inflation down from its record level of 8.1 per cent to the central bank’s target of 2 per cent.

Eurozone bond markets sold off as Lagarde spoke on Monday afternoon. Germany’s 10-year bond yield climbed to 1.75 per cent, while Italy’s rose to 3.67 per cent. Bond yields rise as their prices fall.

The sell-off followed a higher-than-expected demand from IG Metall, Germany’s biggest union, for an annual wage increase of 7 to 8 per cent for 3.8mn metal and electrical workers — among them many in the country’s vast car industry. Higher wages could push inflation up and force the ECB to take more aggressive action to curb price growth.

Asked to justify why the ECB was slower to raise interest rates than the Swiss central bank, which announced a half percentage point rise last week, Lagarde said such comparisons were “odious”. She added: “Circumstances are different, the histories of monetary policy are different, the strength of the currencies are different.”

Some MEPs pressed Lagarde to explain how the ECB would be able to contain the band — or spread — between the borrowing costs of different countries if investors bet in the other direction.

Luis Garicano, a Spanish MEP, asked if the ECB was in danger of “disagreeing with the market on what the band should be and then the risk is that the ECB ends up buying everything and not the market”.

Refusing to give details of how such a new instrument could work or when it would be launched, Lagarde justified it by saying the ECB needed to be “absolutely certain that our monetary policy stance is actually driven to all countries of the euro area”.

Lagarde said: “Fragmentation will be addressed if the risk of it arises; and it will be done so with the appropriate instruments, with the adequate flexibility; it will be effective; it will be proportionate; it will be within our mandate and anybody who doubts that determination will be making a big mistake.”

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