After yet another nasty inflation surprise last month, and with European Central Bank president Christine Lagarde no longer ruling out interest rate hikes in 2022, financial markets have got the message that policy tightening is afoot. Long-term rates have started rising across the eurozone, especially in Italy and Greece, where risk spreads have risen to their highest since the outbreak of the pandemic (165 and 230 basis points, respectively).

While it is right that interest rates should rise to cool demand and prevent high inflation from becoming entrenched in expectations, the process may prove to be messy. This is because the ECB, which meets this week, has repeatedly said it will not raise policy rates until it has ended its sovereign asset purchase programme. Officially, there is no terminal date for the programme. In practice, however, the ECB began tapering purchases this month, and markets have been given the sense that the programme underpinning low and stable bond spreads since 2015 will end by early summer.

Given the current low levels, there is certainly room for interest rates and spreads to rise. But it is also important that spreads be bounded in some way — not least because spiking and volatility in them impede the transmission of monetary policy across the eurozone.