Chart Of The Week   June 15 2022

ECB Pledges New Anti-Fragmentation Tool To Curb Market Stress


Following an emergency meeting on Wednesday, the ECB pledged to “apply flexibility in reinvesting redemptions coming due in the PEPP portfolio” and “accelerate the completion of the design of a new anti-fragmentation instrument” in order to address the “uneven transmission of the normalization of . . . monetary policy across jurisdictions.”

The announcement indicates that the ECB Governing Council aims to address fragmentation risk and that the central bank is prepared to address the situation in peripheral bond markets. ECB board member Isabel Schnabel also stated on Tuesday that the ECB’s commitment to the euro “has no limits.” These announcements reassured investors who were disappointed by the lack of detail on how the ECB will fight fragmentation risk at last week’s meeting. The yield on Italian 10-year BTPs – which surged by 80bps between the conclusion of last Thursday’s ECB meeting and Monday – fell back 36bps on Wednesday.

However, the ECB’s latest pledge leaves many questions unanswered. It is unclear how long it will take to develop and deploy the new anti-fragmentation tool. Its composition is also unknown. Moreover, the various Governing Council members will need to agree to potential conditionalities that are attached to the tool. Disappointments could trigger another sharp selloff in Italian yields. Thus, a durable end to the widening of peripheral spreads will require greater clarity on the new instrument.