Italian and Greek debt costs hit two-year high on eurozone rate fears

Investors rushed out of the debt of Europe’s most highly indebted countries on Friday as the previous day’s hawkish European Central Bank meeting continued to rattle markets, pushing Italian and Greek borrowing costs to their highest level in more than two years.

The yield on Greece’s 10-year bond rose 0.2 percentage points to 4.26 per cent, climbing past the level it reached at the height of the Covid-19 pandemic, while Italy’s 10-year bond yield also jumped as prices fell, trading at 3.67 per cent.

The ECB on Thursday confirmed plans to end its bond-buying programme and raise interest rates for the first time since 2011 next month, and hinted that more aggressive rate rises could follow later in the year.

The move to tighten monetary policy as the central bank seeks to rein in record-high inflation has reawakened investor concerns about the ability of weaker eurozone members to support their massive debt loads without the support of the ECB.

Spanish and Portuguese debt was also hit, while the selling spread to European bank stocks, many of which are heavily exposed to a debt sell-off due to their holdings of government bonds.

Italy’s main stock index was 2.6 per cent lower, led by the banking sector. Lenders UniCredit and Intesa San Paolo fell 5 per cent and 5.3 per cent respectively.

Crucially, Christine Lagarde on Thursday said the central bank could introduce a new tool to avoid “fragmentation” of the euro area by keeping a lid on sovereign borrowing costs, but offered scant details. The ECB president also reiterated that the central bank could reinvest the proceeds of maturing bonds that it holds to ward off bond market stress.

“There are big doubts about whether reinvestments can really help if things start to go haywire,” said Rohan Khanna, a rates strategist at UBS. “There was some hope ahead of the meeting that they were working on some kind of new facility, but Lagarde told us nothing new. The big question clients keep asking is who is going to buy Italian bonds once the ECB backs away.”

The euro extended declines on Friday, falling 0.2 per cent against the dollar to a three-week low of $1.0592. The currency had initially climbed following Thursday’s ECB announcement, but gave up its gains as the market shifted its focus from the prospect of higher interest rates in the eurozone to renewed bond market tensions.

The gap between Italian and German 10-year bond yields, a closely watched gauge of market stress, widened to 2.25 percentage points on Friday, the most since May 2020.

Khanna said some investors had been speculating that the ECB might be forced to step back into markets if this spread reaches 2.5 percentage points — a level that provoked a response from the central bank in the early stages of the pandemic.

“After what we saw yesterday, I think many people are wondering if the level at which the ECB comes in and saves the day is now higher than previously thought,” he said.