MNI INTERVIEW: ECB QT To Fuel Doubts Over "Whatever It Takes"

Investors are likely to question the determination of the European Central Bank to deploy its Transmission Protection Instrument to tame any blowouts in bond spreads if high-debt states come under market pressure at the same time as it is reducing its balance sheet via quantitative tightening, Scope Ratings’ senior director of sovereign ratings Dennis Shen told MNI.

Fiscal discipline will become still more essential if the central bank is perceived to be constrained by its tightening stance, Shen, noting that European Union budgetary rules will start to tighten next year as the escape clause from the Stability and Growth Pact is deactivated.

“If they ever were to use the TPI – obviously they hope not to – but within that confine, where they are tightening monetary policy, but at the same time intervening to correct augmented yield spreads, I would suspect there will be limitations to the efficacy of the programme,” he said in an interview. (See MNI INTERVIEW: TPI A Panic Move ECB Will Lament - Kraemer)

“Markets would question – when the central bank is tightening - how far they could possibly intervene while keeping the balance sheet at the same size or continuing to reduce the size of the balance sheet. The point is that the ECB would no longer have an “infinite arsenal” of purchasing power at its disposal.”

TIGHTER FISCAL POLICY

The upside of this discipline is that fiscal policy is unlikely to complicate the ECB’s job in bringing inflation down, he said. (See MNI SOURCES: Data Deluge Clouds Early ECB September Rate Call)

“Governments have been reducing nominal deficits, but the euro area is going to be in its entirety in [deficit] slightly inexcess of 3% next year. So the fact there will be rules means there will have to be some tightening of fiscal policy.”

Shen conceded that the European Commission’s push for a switch in the EU fiscal regime to one focused on spending benchmarks rather than the 3% of GDP deficit limit will amount to a “technical loosening” of the long-term fiscal framework. But whatever is decided or not in the short term will make little difference.

“Especially with interest rates rising across member states, which has taken up a lot of fiscal space, even if we get some southern Europe version of the fiscal reform, the fact that there will be rules at all means there will be a tightening compared to previous years.”