Central Bank downplays rise in bond yields

Portugal’s central bank governor Mário Centeno has played down the increase in interest rates on Portugal’s 10-year bonds which reached 3% this week.

His attempts to calm the markets comes as the European Central Bank prepares an ‘anti- fragmentation mechanism to reassure markets to try and prevent big differences between the interest paid on bonds in northern European Euro Zone countries and the southern Euro Zone countries like Portugal, Spain, Italy and Greece, which are under investor pressure.
Mário Centeno said this week that the recent increase in interest on public debt was “not a reason to worry”. In his presentation of the Bank of Portugal’s Economic Bulletin for June, Centeno not only played down the issue, but reaffirmed his confidence in the abilities of the European Central Bank.
The governor told Dinheiro Vivo that the ECB was “normalising monetary policy”, something which had been “under preparation since December” when it announced central banks would no longer be buying much sovereign debt via the Pandemic Emergency Purchase Programme (PEPP).
“When the ECB decided to begin returning monetary policy back to normal, it announced that after terminating the period of net purchases through the PEPP (created during the pandemic) it was prepared to use the reinvestments resulting from this programme to flexibly to deal with events that may result in (increased) risks of fragmentation in the Euro Zone. (i.e. higher interest rates on bonds). This is the remedy that is now being put forward”, he said.
Mário Centeno stressed that what was now bring prepared is a new ‘anti-fragmentation’ instrument at the same time as monetary policy was being ‘normalised’ to avoid significant differences between the interest rates in countries in the south of Europe such as Portugal, Spain, Greece and Italy, with those in the north of Europe.
The Governor of the Bank of Portugal refused to detail the characteristics of the new instrument, because it was still under development, simply saying“it is not a normalisation process in itself, it is just a (mechanism) to create the conditions so that the normalisation process can be achieved without the risk of fragmentisation”.
It comes as the Fed announced it was raising benchmark interest rates three-quarters of a percentage point — the largest jump since 1994 — to a range of 1.5%-1.75%. It’s likely not the last increase; the rate-setting Federal Open Market Committee forecasted that rates will continue to go up in the coming months and may reach 3.8% next year.
Switzerland’s central bank has followed suit by raising interest rates for the first time in 15 years (by half a percent), in a bid to prevent inflationary pressures on the Swiss economy. The Swiss National Bank (SNB) said on Thursday that its benchmark rate would rise from -0.75% to -0.25%.
The Bank of England’s Monetary Policy Committee also voted to raise UK interest rates to a fresh 13-year high at its meeting this week, the fifth rate rise in a row, despite concerns that the economy is weakening. The move comes after UK inflation hit a 40-year high of 9% in April.
On Wednesday, the ECB had confirmed that it planned to create a new tool to tackle the risk of fragmentation and a new sovereign debt crisis as happened a decade ago. (Sovereign Debt Crisis)
“Since the gradual process of policy normalization was initiated in December 2021, the Governing Council has pledged to act against resurgent fragmentation risks,” the ECB said in a statement.
“The pandemic has left lasting vulnerabilities in the euro area economy which are indeed contributing to the uneven transmission of the normalization of our monetary policy across jurisdictions,” it added.
The comments reflect the recent surge in bond yields over the past week or so. After a regular policy meeting last week, the ECB suggested a more aggressive policy tightening but failed to deliver any new measures to support highly indebted nations in the bloc.
Isabel Schnabel, a member of the ECB’s executive board, said in Paris on Tuesday: “Our commitment to the euro is our anti-fragmentation tool. This commitment has no limits. And our track record of stepping in when needed backs up this commitment.”
It is thought that the ‘flexible reinvestments’ that Mário Centeno is referring to might buy policymakers a little time, but may not go far enough”.
Mario Centeno, who sits on the ECB Governing Council, said “faster monetary policy normalization is a risk that cannot be ruled out”, according to Reuters. The central banker added that the pace of interest rate hikes would be “gradual.”