Italy, Greece Caught in Bond Rout Pose ECB With Another Headache

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When the bonds of Europe’s peripheral countries lead a selloff, it’s not normally a good sign.

Greek securities are on course for their worst week since April, while Italy’s 10-year yield spread over Germany -- a key gauge of risk in the region -- climbed above 100 basis points for the first time since Mario Draghi became prime minister earlier this month.

Italy, Greece Caught in Bond Rout Pose ECB With Another Headache

Though the rising premiums are small by recent historical standards, it’s still a concern for the two most indebted countries in the euro area -- and for the European Central Bank, which is using spread levels as a key method to loosen financial conditions across the bloc. Rising yields in the periphery have long been a warning sign for the region at large.

“These levels should make the ECB uncomfortable,” said Piet Christiansen, chief strategist at Danske Bank A/S. “When the selloff in European bonds happen alongside spread widening -- and no impact on inflation expectations -- that is a major risk in my view.”

The ECB’s Chief Economist Philip Lane said Thursday that the institution is closely monitoring longer-term bond yields, while flexibility in its purchases would prevent financial tightening.

Further signs of weakness in European bonds emerged Thursday, with an Italian sale of five-year debt receiving the lowest demand since June. Yields surged across the region, with 10-year French rates climbing above 0% for the first time since June.

The moves come as global debt markets are in the midst of a rapid selloff, with the epicenter in the U.S., where President Joe Biden’s $1.9 trillion stimulus package is fueling bets for faster inflation. In the U.K., the nation’s rapid vaccine rollout is boosting hopes for a swift end to lockdown measures and has resulted in the biggest rout in gilts for more than four years.

Inflation expectations in the euro area have so far lagged behind. The spread between German bonds and their U.S. and U.K. counterparts is at the largest since at least the coronavirus-induced meltdown in March. Yet investors scarred from the sovereign debt crisis nearly a decade ago will know that it’s the peripheral nations in Europe that are most vulnerable to rapid price swings.

Greek 10-year yields have climbed about 20 basis points this week, surpassing 1% for the first time since October. Those in Italy have risen more than 10 basis points during the last three sessions to 0.73%, taking the spread over their German peers to 100 basis points.

The ECB has bought more than 17 billion euros ($20.8 billion) of bonds under its pandemic program in each of the two weeks until Feb. 19. That’s an increase of almost a third compared to the average since mid-January. Yet even so, Greek bond holders have lost 2% this month alone, compared to a gain last year of 4%, according to Bloomberg Barclays indexes.

“Though the ECB has increased its pace of purchases, rates continue to edge higher,” said Pooja Kumra, senior European rates strategist at Toronto-Dominion Bank. “The markets have rejected any dovish talk from central banks.”

©2021 Bloomberg L.P.

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