European Central Bank rallies after rising borrowing costs

The European Central Bank’s Rate Setting Council is set to hold an unscheduled meeting on Wednesday “to discuss market conditions,” with borrowing costs rising for several countries after the bank announced it would hike interest rates.

The bank last week announced the July and September hikes without specifying how it would protect countries sharing the euro currency if borrowing costs rise excessively — as they did in the 2010-2012 European debt crisis. This is a problem for highly indebted governments, especially Italy.

Spreads on Italian and Spanish debt over safe German sovereign debt – a key fear index for the 19-nation euro zone – have widened after the ECB made only vague promises to prevent financial “fragmentation” or so high interest rates in individual countries that they do not reflect the bank’s benchmarks.

The ECB has a bond market backstop it could step into and buy the debt of a troubled country. This tool helped calm the debt crisis a decade ago, after the bank announced it in the wake of then-President Mario Draghi’s pledge to do “whatever it takes” to prevent a eurozone breakup. But this program, which actually never needed to be used, can come with stressful conditions.

Holger Schmieding, chief economist at Berenberg Bank, said the “situation today is different than the euro crisis just over a decade ago” because the countries’ growth prospects are improving and the ECB has the bond market in its pocket if needed.

The current conditions “should not pose an immediate risk even for financially troubled Italy,” he said.

The surprise ECB meeting comes on the same day that the US Federal Reserve is expected to announce its biggest rate hike since 1994.

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