Nevertheless, if persistent, they complicate monetary policy as they drive a wedge between the risk-free rate and national borrowing conditions. As these wedges are a feature of the euro area’s institutional architecture, addressing them lies firmly in the hands of governments. There are times, however, when yields rapidly diverge from economic fundamentals, causing financial instability and hence fragmentation.
Put simply, fragmentation reflects a sudden break in the relationship between sovereign yields and fundamentals, giving rise to non-linear and destabilising dynamics. [1] Such excessive yield movements may be driven by factors related to market liquidity or speculative market behaviour in the form of self-fulfilling market dynamics.