By Anna Hirtenstein 

Despite European Central Bank President Christine Lagarde's statement earlier this year that it isn't the central bank's job to close spreads, that is precisely what it has done.

The cost of borrowing for Europe's riskiest governments has returned to pre-coronavirus lockdown levels, indicating that the central bank has effectively created a backstop to the monetary union's debt market.

The spread, or difference between yields, on Greek and Italian government bonds compared with German bonds Wednesday hovered near the tightest level since before panic about the coronavirus overtook markets. The difference between the yields on eurozone countries' bonds is seen as a barometer of financial stress in the region. The wider the spread, the more worried investors are.

The yield on Greece's 10-year debt was at 1.032% and Italy's at 1.204%, on Wednesday according to Tradeweb, the lowest since March and below where they began the year. For both, that is over a full percentage point less than at the height of the turmoil. Bond prices rise as yields fall.

"If you know that the ECB is there to protect the spread market, why would you want to bet against it?" said Peter Schaffrik, a global macro strategist at RBC Capital Markets. The central bank "has made huge contributions to stability in financial markets. The market is reassured."

This is despite historic contractions in European countries' economies resulting from the lockdowns and a surge in debt issuance as governments seek to fund their fiscal stimulus programs.

Italy was the first country in the region to implement a lockdown in early March and subsequently its economy is expected to be the worst-hit in the trade bloc in 2020. The European Commission is forecasting that it will shrink 11.2%. Greece is predicted to contract by 9%, compared with an expected decline of 8.7% across the euro area.

Ms. Lagarde said on March 12 that the ECB was "not here to close spreads." After a sharp sell off in southern European government debt, she quickly pivoted to echo the rhetoric of her predecessor. Mario Dragh, pledging to do "everything necessary" to help the eurozone through the crisis. Six days later, the ECB announced a EUR750 billion ($846.84 billion) bond-buying program, which was expanded to EUR1.35 trillion on June 4.

This program is expected to vacuum up net issuance of government debt through to next year, according to research from J.P. Morgan Asset Management.

Also providing reassurance to investors is the European Recovery Fund, a EUR750 billion plan put forward by the European Commission which is backed by heavyweights Germany and France. It proposes to provide capital to EU countries through a mix of grants and loans. For the first time, large-scale common debt issuance is also on the table, which would lower the burden on the most vulnerable countries.

While the proposal still needs to be agreed on unanimously by all member states, investors are optimistic that Europe's weaker nations will be supported. EU leaders are meeting next week in Brussels for a summit where more details are likely to be hammered out.

The ECB's governing council will also issue an update on July 16. It is largely expected to keep monetary policy stable.

"The policy response is very strong, from the point of view of the size of ECB purchases and the size of the recovery fund," said Seamus Mac Gorain, head of global rates at J.P. Morgan Asset Management. "We actually think spreads could be even narrower at the end of the year."

In the U.S., yields on benchmark 10-year Treasury notes rose to 0.656% from 0.648% on Tuesday.

--Pat Minczeski contributed to this article.

Write to Anna Hirtenstein at anna.hirtenstein@wsj.com

(END) Dow Jones Newswires

July 08, 2020 09:30 ET (13:30 GMT)