Italian Bonds Are at the Mercy of the ECB
Policymakers should resist the urge to accelerate balance-sheet reduction.
Italian air force jets fly over the Autodromo Nazionale Monza circuit leaving traces to the colors of the Italian flag prior to the start of the Italian Formula One Grand Prix race.
Photographer: Ben Stansall/AFP via Getty Images
It’s been a stressful time for Italy’s 10-year bond, with its yield rising tenfold in the past two years and brushing 5% this month. While borrowing costs haven’t outpaced those of its peers despite the country being perceived as one of the euro area’s weakest economies, Italian debt is at the mercy of the European Central Bank’s stance on running down its swollen balance sheet. Policymakers need to tread cautiously.
As one of Europe’s weaker sovereign credits, Italy is particularly vulnerable to the ECB’s attempts to curb inflation by raising interest rates, which have seen the deposit rate increase by 450 basis points in just 15 months. And although the central bank kept policy unchanged last month and is expected to stay on hold again Thursday, there’s a risk the Governing Council will switch to a different flavor of monetary tightening by accelerating the unwind of its bond portfolio. That would be dangerous.