[ECB raises interest rates] European debt crisis 2.0 brewing?

After years of ultra-loose monetary policy, the European Central Bank announced earlier this month that it would stop net asset purchases from July 1 and plans to raise interest rates by 0.25% in July, paving the way for the first rate hike in more than a decade.

The analysis believes that the European Central Bank has taken an important step in the right direction, but it must guard against the risk of debt crisis that may be brought about by raising interest rates.

The ECB has always been more cautious and restrained than the Fed.

In the fourth quarter of last year, the Fed began to pull back from easing, but the ECB did not immediately follow suit.

According to the ECB's forecast, the inflation rate in the euro area will reach 6.8% in 2022, and will fall to 3.5% and 2.1% in 2023 and 2024, respectively, exceeding the expected target of 2%.

European Central Bank President Christine Lagarde said earlier that inflation is expected to remain high for some time.

The European Central Bank is expected to raise interest rates again in September, and if the medium-term inflation outlook continues or deteriorates, the rate hike will be appropriately increased.

European Central Bank President Christine Lagarde said earlier that if the medium-term inflation outlook persists or deteriorates, the rate hike will be appropriately increased.

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After the "official announcement" of the European Central Bank's austerity plan, the European bond market caused a storm.

Italy's 10-year government bond yield hit 4 percent for the first time since January 2014, and the cost of insuring its debt exposure rose to its highest level since 2020.

A barometer of financial stress in the euro zone, the spread between Italian and German benchmark 10-year government bond yields widened to 2.4%, close to the 2.5% threshold.

Spreads over 10-year German bund yields in other southern European fringe countries Spain and Portugal also reached their highest levels since 2020.

Five-year credit default swaps in Italy and Portugal rose to their highest levels since 2020.

Italy has had years of sluggish economic growth and ballooning government debt, most worrisome in what traders call a "doomsday cycle" - Italian banks hold large amounts of government bonds, and as yields on those bonds rise, A drop in bond prices could affect a bank's ability to lend or threaten its solvency, leading to a default.

Some experts pointed out that European countries can intervene in the government bond market in a more targeted manner to prevent new crises.

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The European Central Bank is worried that the current high borrowing cost in Italy will affect the sustainability of the country's government debt; at the same time, the government borrowing cost is still the floor price for the overall financing cost of companies and households, which will have a knock-on effect.

In 2012, when then-ECB President Mario Draghi announced that the ECB would "do whatever it takes" to defend the euro, European inflation was 2.35%.

At that time, the European Central Bank resorted to unprecedented monetary easing to defuse the euro crisis.

But now that inflation is high, it is impossible to resort to unprecedented monetary easing as last time.

With no coping tools and soaring borrowing costs, will there be a European Debt Crisis 2.0?

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For details, please read the 323rd issue of "Hong Kong 01" Electronic Weekly (June 27, 2022) "The