The European Central Bank is this week set to strengthen its commitment to prop up vulnerable eurozone countries’ debt markets if they are hit by a sell-off, as policymakers prepare to raise rates for the first time in more than a decade.

The bulk of the 25 governing council members are expected to support a proposal to create a new bond-buying programme if needed to counter borrowing costs for member states, such as Italy, spiralling out of control, according to several people involved in the discussions.

Even without a new scheme, the ECB already has an additional €200bn to spend on purchasing stressed government debt under its existing bond-buying programme. That €200bn would come from bringing forward reinvestments of maturing assets by up to a year.

Rate-setters, who meet in Amsterdam on Wednesday and Thursday, are likely to clash over when to stop buying more bonds. Some plan to call for purchases to be halted as soon as Thursday, several weeks ahead of schedule, although they concede that only a minority may support the idea.

The bank is under pressure to react to record-high inflation, but has lagged behind its counterparts in the US and UK in tightening monetary policy. Many of the council’s hawks have accepted that they will need to provide more support for bond markets to clear the way for being more aggressive in raising rates.

Almost all of the council accept that the ultra-loose monetary policy it has pursued for over a decade needs to end. A rise of at least 25 basis points is all but certain to happen at the ECB’s next policy meeting on July 21. The deposit rate is now minus 0.5 per cent.

Citizens in the region are facing a surge in the cost of living, aggravated by Russia’s invasion of Ukraine. Consumer prices in the eurozone rose 8.1 per cent in the year to May — quadruple the ECB’s 2 per cent target and double the previous high since the single currency was launched in 1999 — forcing governments to pay subsidies to cushion the impact of higher energy and food prices on households.

Line chart of  showing Eurozone inflation has soared above the ECB's target

However, some are concerned about the market fallout from raising rates and want a firmer commitment to launch a new bond-buying scheme to counter any unwarranted surge in the borrowing costs of heavily indebted countries.

ECB president Christine Lagarde said in a blog last month: “If necessary, we can design and deploy new instruments to secure monetary policy transmission as we move along the path of policy normalisation, as we have shown on many occasions in the past.”

Several council members said they would support adding similar language to its statement on Thursday, building on a promise made after its meeting in April to maintain flexibility when its price stability target is threatened “under stressed conditions”.

The spread between Germany’s benchmark 10-year bond yield and that of Italy — a closely watched yardstick of financial stress in the eurozone — rose last week to its highest level since a sell-off in southern European bond markets at the start of the pandemic in 2020.

The central bank has previously said that its continuing €20bn-per-month asset purchase programme would not end until early July and only “some time” after that would it consider raising interest rates.

The policymakers planning to call for an immediate end to additional bond purchases this week believe there is no longer any justification in continuing a policy designed to boost inflation. Others insisted that it was more credible to stick to the plan for bond-buying to continue until early July. The ECB declined to comment.

Carsten Brzeski, head of macro research at ING, said bringing forward the end of bond purchases by a few weeks would “be a clear hawkish surprise” and could even open the door to the possibility of raising interest rates before its meeting on July 21.

The ECB has bought more than €4.9tn of bonds in total, equivalent to over a third of eurozone gross domestic product, since launching its quantitative easing programme to tackle the dual threat of deflation and a sovereign debt crisis in 2014.

Over the past two years, it has bought more than all the extra bonds issued by the eurozone’s 19 governments, giving it vast sway over borrowing costs in the region.

The ECB has also been slower to stop buying more bonds than most western central banks. Some, such as the US Federal Reserve, have even started shrinking their balance sheets by not reinvesting the proceeds from maturing bonds.



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