The Governing Council of the European Central Bank (ECB) held a late-breaking special meeting on Wednesday to explore ways to gain control over the diverging euro-zone government bond yields.

As a first step, the Council has given itself the opportunity to reallocate the portfolio of bonds originating from the pandemic program and thus to purchase more bonds from countries such as Italy.

Gerald Braunberger

Editor.

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This is done through flexible handling when replacing maturing bonds with new paper.

For example, maturing German government bonds can be replaced by Italian government bonds.

This possibility had been considered for the past few weeks;

however, many experts do not consider it sufficient to calm the bond market in the long term.

As a further step, the Central Bank Council has therefore commissioned the development of a new tool with which the ECB intends to prevent bond yields from diverging in the future.

What this program might look like is still unclear.

Some observers had hoped for more far-reaching decisions from the special session.

As a first reaction, the euro depreciated slightly.

Unrest in the ECB

The convening of the approximately three-hour special meeting speaks for considerable unrest in the management of the ECB with a view to a possible new euro crisis.

In the past few weeks, the yield spreads between ten-year Italian and German government bonds had widened significantly;

eventually they reached around 2.4 percentage points.

This is above the long-term average of yield differences, but is not yet exceptional: In the euro crisis of 2012, this gap was much larger at more than 5 percentage points.

The European Central Bank sees sharply rising yield spreads as an obstacle to the proper implementation of its monetary policy, provided that the yield differences cannot be explained by economic data, but are caused by economically unfounded market speculation.

These impediments to monetary policy are known in the technical jargon as “market fragmentation”.

Just under a week ago, the ECB announced that it would end its net purchases of government bonds at the end of June and start raising interest rates by 0.25 percentage points in June, which should be followed by the next increase in interest rates in September.

Then the period of negative key interest rates that has lasted since 2014 should come to an end.

In view of the sharply rising inflation rate, the ECB feels compelled to “normalize” its monetary policy.

However, it is much slower than many other central banks when it comes to raising interest rates.

Bond yields are rising everywhere

The impromptu Federal Reserve Board meeting came hours before a meeting of the US Federal Reserve's Open Market Committee, which many observers are expecting to raise US interest rates by 0.75 percentage points.

In May, inflation was 8.6 percent in the United States and 8.1 percent in the euro zone.

With inflation rates rising, bond yields around the world have risen significantly without panicking other central banks.

For example, Australian and New Zealand ten-year government bonds are yielding around 4 percent, about the same as ten-year Italian government bonds.

Recently, even yields in Japan had risen, although the Bank of Japan has been trying to tightly control yields for years.

In many markets, sharp changes in bond prices have been accompanied by a drop in liquidity.

Again, this phenomenon is not limited to the eurozone.

"This is the return of the euro crisis"

Experts assess the situation in the euro zone differently.

The President of the Ifo Institute, Clemens Fuest, commented succinctly: "What is happening here is clear: this is the return of the euro crisis." For Holger Schmieding, chief economist at Berenberg, the situation is less clear.

"The ECB, including the national central banks, has bought up practically the entire net increase in public debt since 2015," wrote Schmieding immediately before the meeting.

“Government debt held by the central bank is not really market-relevant public debt, as central banks transfer part of their interest income from the bonds to finance ministers as a profit.

Adjusted for stocks held by central banks,