The ECB itself is facing drastic decisions: Central bank chief Christine Lagarde wants to present plans for a new instrument in addition to the first interest rate hike to prevent fragmentation in the euro area, i.e. a wide divergence in bond yields between the member countries.
The decision could shape the monetary union in the long term and lead to new legal disputes as to whether the central bank is engaged in prohibited state financing. Unlike an interest rate decision, the decision on the new crisis prevention instrument cannot be corrected a few months later.
The background is the strong increase in yields, especially in Italy. These have risen significantly since the ECB announced the first interest rate hike in eleven years for the summer in mid-May. Parallel to the increase in risk premiums for Italian government bonds, fears of a new euro crisis grew.
Top jobs of the day
Find the best jobs now and
be notified by email.
The central bank wants to curb this risk with the new instrument. But the concept is extremely controversial. Critics warn that the instrument reduces the ECB’s incentives for sound budgetary policy and makes itself legally vulnerable.
Pressure on the ECB has increased
According to Governing Board member Isabel Schnabel, the central bank only wants to react if yields in individual countries shoot up for speculative rather than fundamental reasons. However, the current government crisis in Italy shows how difficult this distinction is.
Italy’s Prime Minister Mario Draghi (M) has offered his resignation.
(Photo: dpa)
“The Italian government crisis shows the limits of the new instrument before it was even presented,” says the economist at the major Dutch bank ING, Carsten Brzeski. From his point of view, the pressure on the ECB has “significantly increased” to present something next Thursday. It has now become even more difficult to determine a justifiable level for spreads.
Commerzbank chief economist Jörg Krämer assumes that the ECB would set such a level “in case of doubt too low in order to be able to help highly indebted countries like Italy more easily”, whose supporters would have a majority in the Governing Council.
Yields on bonds in the euro zone have risen significantly since mid-May after the ECB signaled that interest rates would rise soon. The movement was particularly pronounced for Italian government bonds: the yield rose from below 2.9 percent in May to almost 4.3 percent.
As a result, the ECB Governing Council held a special meeting on June 15 and announced the new instrument that the central bank intends to use to tackle fragmentation. Details are to follow on Thursday.
>> Read about this: The return of the euro crisis: “The rise in interest rates is dramatic”
However, it is questionable how explicit the ECB will be. Because the clearer it becomes here, the more legally vulnerable it could become. However, it is considered likely that the ECB will not name any fixed upper limits for the risk premiums of individual countries.
Proponents argue that the instrument would make it easier for the ECB to raise interest rates across the board. If yields in countries like Italy or Spain rise much more sharply than in Germany, for example, as a result of tightening monetary policy, it could become more difficult to push through interest rate hikes.
Rising yields on government bonds are also driving up financing costs for companies in the respective country. This is particularly problematic for highly indebted Italy.
Critics, on the other hand, also point to legal problems because the ECB could expose itself to suspicion of operating state financing, which it is not allowed to do according to its statutes.
The announcement of the new instrument initially had an effect on the financial markets: the yields on Italian government bonds fell and fell to just over three percent by the beginning of July. This is a clear move for the bond market.
Recently, however, yields have risen again overall due to high inflation and the expectation of stronger interest rate hikes. Due to the government crisis in Italy, however, the development of Italian government securities is more extreme. Yields rose faster than those for the 10-year German bond.
Yields are picking up again
As a result, the risk premium (spread) for Italian securities compared to federal bonds climbed again: at the beginning of July it was below 1.9 percentage points – on Thursday it rose again to the 2.2 percentage point mark as a result of the government crisis.
Spreads stabilized on Friday. But that doesn’t mean a lasting relaxation, says Monica Defend, head of the Amundi Institute: “The political noise will continue and cause volatility on the markets.”
Helaba’s bond expert, Ralfcircul, does not consider the spread level to be extraordinarily high in a historical comparison. But it is also clear: “If Mario Draghi no longer has a majority in Parliament next week, then we will be in a political mess.” Certain concerns are therefore justified.
“Italy is heavily indebted. If spreads widen, financing will become more difficult for the Italian government. And Italy is important for the euro zone simply because of its sheer size, that would be a completely different case than Greece,”circulated.
Economists demand clear conditions from the ECB
Economists are also discussing the consequences of the government crisis in Italy for the ECB on Twitter. Mannheim economics professor Klaus Adam questioned whether the central bank’s implicit promise to contain spreads between member countries had contributed to the withdrawal of the Five Star Movement party from government in Italy.
From Adam’s point of view, it is crucial that the ECB’s aid is tied to clear conditions. So far, there has been speculation about comparatively soft conditions, which could be similar to the EU’s Corona reconstruction fund, for example.
Referring to the government crisis and the increase in Italian spreads, Stefan Gerlach, chief economist at the Swiss EFG Bank and former deputy head of the Irish central bank, wrote: “It is not the job of the ECB to save Italy from Italian politicians.”
The former economist Volker Wieland also expressed a similar opinion: “If Draghi’s reform program collapses with him, it cannot be the task of the ECB to use a new purchase program to prevent increases in risk premiums that result from irresponsible politics.”
So the ECB is under even more pressure to come up with something at its meeting on Thursday, while the task of constructing a legally watertight yet effective instrument has become even more difficult.
ING economist Brzeski believes expectations will be difficult to meet. “Only if the ECB makes another promise, whatever-it-takes, could further speculation be ended,” he says, alluding to the intervention of the then ECB chief and current Italian Prime Minister Mario Draghi.
Draghi had said in July 2012 that the ECB would “do whatever it takes to preserve the euro”. However, Brezski fears that the ECB will not be able to meet expectations this time.
More: Interview with Markus Brunnermeier: “Inflation requires aggressive action by the ECB”