European Central Bank (ECB) President Christine Lagarde speaks during a news conference following the ECB’s monetary policy meeting, in Frankfurt, Germany, July 21, 2022.
Wolfgang Rattay | Reuters
The European Central Bank toughened its anti-inflationary stance with a 50 basis point hike in interest rates and announced a new anti-fragmentation tool, but analysts are not convinced these measures will tackle the myriad challenges economies in the euro area.
Thursday’s 50 basis point hike in the policy rate was broadly welcomed by the market and commentators alike, with inflation hitting a record high in the common 19-member currency bloc and the ECB lagging its benchmarks. peers in launching the monetary tightening process. .
However, this aggressive move comes against a backdrop of slowing growth and risks tipping the economy into recession, as external pressures stemming from the war in Ukraine and associated energy supply problems show few signs of easing. appeasement.
An unexpected contraction in the Eurozone PMI (Purchasing Managers Index) figures in July will only heighten these concerns. Capital Economics said the new data suggests “the eurozone is on the brink of recession due to collapsing demand and rising costs.”
The Frankfurt-based institution has also launched the Transmission Protection Instrument (TPI), an anti-fragmentation tool aimed at supporting countries with high debt and high borrowing costs, such as Italy, and at limiting gaps between states. members of the euro zone.
The TPI can be activated to counter “unwarranted and disorderly market dynamics which pose a serious threat to the transmission of monetary policy in the euro area”, the ECB said.
Details released later on Thursday showed that the tool could be used when certain countries see their borrowing costs increase due to factors beyond their control, provided that these countries stick to “fiscal and macroeconomic policies healthy and sustainable.
However, the fuzzy nature of the application of the new tool and its place in the contemporary function of monetary policy has raised more questions than answers for many analysts.
TPI – addressing the symptom rather than the cause
Clemens Fuest, president of Germany’s Ifo Institute for Economic Research, said in a statement on Friday that he welcomed the surprisingly large increase in the key interest rate, but criticized efforts to limit spreads between borrowing costs of different nations.
“Interest rate differentials are part of a functioning capital market because they reflect different levels of risk, and private investors need to be convinced to take those risks,” Fuest said.
“There is a danger that the ECB will cross the line by funding governments here, undermining its independence and putting in place the wrong incentives for fiscal and economic policy.”
He argued that if individual member states are in financial difficulty, it is not the job of the ECB to intervene, but rather that of the eurozone governments and the bailout fund of the ESM (European Stability Mechanism). ).
The ESM has disbursed funds to help countries like Spain, Greece, Portugal, Cyprus and Ireland recalibrate their finances since its inception in 2012 through loans and other forms of financial assistance.
“The conditions set by the ECB that a country must meet to receive financial support from the ECB are significantly weaker than those of the OMT bond purchase program put in place during the euro crisis, which requires at least an MES program with far-reaching measurement conditions,” Fuest added.
He suggested that unlike the OMT (Outright Monetary Transactions) program – in which, under certain conditions, the ECB makes secondary purchases of sovereign bonds issued by eurozone member states – the ECB is not bound by any decision other institutions in its TPI programme, which makes it vulnerable to political pressure to offer budgetary support to indebted member states.
Fuest’s skepticism was echoed by Cardano senior economist Shweta Singh, who said in a note on Thursday that the TPI rollout is subject to “a lot of constructive ECB-style ambiguity.”
“Eligibility, activation and termination criteria are all subject to the judgment and discretion of the General Counsel. The timing of the TPI announcement coincided with the widening of BTP-Bunds spreads due to the increased political instability in Italy and raises some interesting questions,” Singh said.
The spread between Italian and German bond yields is seen as a measure of stress in European markets – or a gauge of fear – and has widened in recent months to its highest level since May 2020.
Renewed political instability in Italy following the resignation of Prime Minister Mario Draghi, giving way to new national elections on September 25, further undermined investor confidence.
Singh said the key questions would be whether the ECB would act when spreads widened due to political concerns, as is currently the case, and how the Governing Council would define an “unwarranted” widening of spreads.
“In any case, we believe that the TPI is more likely to address the symptom (wider spreads, higher risk premia) rather than the cause (underlying differences in competitiveness, growth potential, leverage levels, fiscal governance) and may have a limited impact on keeping spreads lower for longer,” she said.
“Absent concrete details, we believe markets will test the ECB and although approval of the TPI was unanimous, implementation will be plagued by monetary funding concerns.”
Despite the vagueness surrounding the TPI’s candidacy, several analysts have deemed it “credible” for the moment.
BNP Paribas’ senior European economist, Spyros Andreopoulos, said in a note on Thursday that the TPI “seems credible to us over the medium term, based on the combination of ECB discretion and the absence of an ex- ante”.
“However, the activation threshold is likely high, suggesting that markets could still test the ECB in the near term,” he added.
UBS’s chief eurozone economist Dean Turner and chief credit officer Thomas Wacker also acknowledged the lack of detail, but said “the outline of the TPI seems to have bought the ECB enough credibility in the eyes of investors”.
“The real test will come when conditions deteriorate to the point that the ECB will have to use the TPI, which they hope its very existence will prevent,” UBS said.