The change of direction of the ECB’s monetary policy: relation with sovereign spreads and future challenges

The euro area over the last decade had to face multiple challenges in dealing with the consequences of the financial crisis of 2008 and the more recent crisis brought on by the COVID pandemic. The ECB has expanded its toolkit in conducting monetary policy, adding to the conventional interest rate setting, new and unconventional instruments, such as negative interest rates, asset purchases, extending loans to financial institutions, and forward guidance, in order to steer inflation towards the target and to preserve a smooth transmission of monetary policy. In 2021, the ECB has started moving towards a restrictive monetary policy, gradually increasing the policy interest rates and interrupting the purchases of assets. However, according to the research of Reichlin, Ricco and Tuteja (2022), if an increase in the interest rates is accompanied by high sovereign spreads of euro area  countries, the restrictive monetary policy could have undesired effects on inflation, GDP and the stock markets. At present, the ECB has to face new challenges, namely a rising inflation and the consequences of the Russia-Ukranian conflict.