The European Central Bank reacted on Wednesday to soaring bond yields – primarily in Mediterranean member-states such as Greece – and its intervention had an immediate impact on the markets.
At an extraordinary meeting of its Governing Council, the ECB decided to allocate more funds for the acquisition of bonds of countries under the greatest pressure, including Greece and Italy, as well as to order the formation of a mechanism that will intervene whenever necessary.
From the beginning of June until the intervention of the ECB, the yield of the Greek 10-year had jumped by 38% and topped the “prohibitive” rate of 4.7 percentage points. Likewise, the Italian 10-year yield exceeded the 4% barrier for the first time since the end of 2013.
The ECB’s commitment to contain the spreads resulted in a very positive initial reaction from the market, with eurozone bonds rallying sharply and returning to pre-PEPP levels last week. The yield of the Greek 10-year note fell by 9% to 4.25 percentage points on Wednesday, while the spread with the German Bund narrowed to 260 basis points.
The dip in the yield of 10-year Italian bonds was of a similar magnitude, as it stood at 3.85 percentage points with the spread moving to 222 basis points. At the same time, the yield of the German 10-year paper moved to 1.6 percentage points with a fall of 7.4%, dragging the rest of the bonds in the region lower.
Analysts however believe that only the implementation of a new tool would be able to lead to a lasting reduction of spreads, and that reinvestment is not enough. An estimated 200 billion euros in PEPP bonds expire in the next 12 months, but even if the full amount is put forward, it may not be enough.
“Even the full distribution of PEPP reinvestments in the peripheral countries would represent only one third of the total gross supply. While the PEPP reinvestment announcement may be enough to appease markets in the short term, it is unlikely to be fully adequate to address the risk of fragmentation,” said Morgan Stanley.