Hawkish ECB Sparks Peripheral Spread Blowout… That The ECB Will Have To Bailout

With The ECB forecasting slowing growth and worsening inflation amid a hawkish rate-hike outlook and an imminent start to its QT plan, things have started to go just a little bit turbo in European sovereign bond markets.

Lagarde made it very clear there was no pause or pivot on the horizon:

“Anybody who thinks that this is a pivot for the ECB is wrong,” the ECB president told a news conference. “We should expect to raise interest rates at a 50 basis-point pace for a period of time.”

“We have more ground to cover, we have longer to go and we are in for a long game,” she said adding that “we will sustain a course, it will not be enough to hit and withdraw, we will sustain the course because we want those levels of inflation to remain at those restrictive levels long enough so that we can be confident that inflation returns to target.”

Additionally, Lagarde said financial markets hadn’t adequately accounted for the amount borrowing costs would need to rise to quell inflation.

And that is starting to be reflected in European capital markets as EU stocks have extended their declines…

…as yields climbed further, led by the short-end of European bond curves.

Bund and gilt yield curves bear flattened, while peripheral spreads widened to Germany.

The ECB’s tightening campaign this year has revived long-standing questions over the sustainability of Italy’s government debt load.

ECB policymakers will be careful not to reignite the pressures on fragile economies that have previously threatened to tear the currency bloc apart, Deutsche Bank analysts said Friday.

“We doubt the ECB would want to provoke material concerns over Italian debt sustainability, at a time of maximum economic uncertainty,” the Deutsche Bank team wrote.

However, as a reminder, the last time spreads started to blow out, The ECB blamed “uneven transmission” of monetary policy and unveiled plans for their “anti-fragmentation policy and tools.”

Translation: More QE (for peripherals) as they promise more QT and rate-hikes?!

So, the question is – will the ‘hawkish’ ECB respond with a ‘dovish’ bailout of these EU-existential-threatening peripheral bond risk explosions. We suspect the market will, once again, call Lagarde’s hawkish bluff on QT.