MNI INTERVIEW: ECB To Clarify TPI In Coming Weeks - EP Adviser

The European Central Bank is likely to provide additional detail on its Transmission Protection Instrument in the coming weeks, including how any losses would be shared between national central banks, as it readies its new tool for use in the event of a blowout in eurozone spreads, an advisor to the European Parliament told MNI.

The ECB is likely to use its capital key, which is calculated according to member states’ shares of eurozone output and population and also incorporated into rules for its Securities Markets Programme and its Outright Monetary Transactions, as a guide for sharing out the TPI's risk, Kerstin Bernoth of the German Institute for Economic Research (DIW Berlin) said in an interview.

It is also likely to provide reassurance that the TPI, which was announced in July and would allow the ECB to support member states’ government debt if a sell-off takes yields out of line with fundamentals, will not stray over the line into direct monetary financing, she said, adding that an announcement can be expected by the end of the year.

“The solution might look the same as for the SMP and OMT - the capital key. That’s something they could clarify in the coming weeks. I can’t see how they could do it otherwise,” said Bernoth, co-author of a legal and economic analysis of TPI recently presented to the EP’s ECON committee.

“The issues surrounding the prohibition of monetary financing are easy for them to fix,” Bernoth added. “I expect them to give more details on the TPI in the next one to three months in order to indicate that they would be ready.”

LEGAL CHALLENGES

The legal framework is still not in place for the TPI to be deployed, Bernoth said, noting that markets will become increasingly conscious of its lack of readiness unless its details are finalised.

“I would assume immediately when they start using TPI that they will get in trouble with, again, German economists appearing in front of the German Constitutional Court,” she said. “The announcement so far is so imprecise, I would say as soon as they start using it they will run into trouble.”

Among issues not yet publicly resolved are whether there will be a time lag between the issuance of bonds and their purchase by the ECB, which spreads should be monitored and how to determine whether or not they are unwarranted. (See MNI SOURCES: Majority Sufficient For ECB's New TPI Tool)

Perhaps the most difficult legal issue facing the ECB is its status as exclusive arbiter of whether or not a country is eligible for TPI intervention, Bernoth said, adding that this will raise questions over whether it will prioritise fighting inflation over its desire to protect monetary union.

“It’s not that easy for them to fix the criticism that the ECB has sole discretion to activate TPI, especially when there is political pressure for them to do so,” she said. “Of course, in view of high inflation, the ECB also faces political pressure to raise interest rates, so it's very difficult to say whether the ECB will nevertheless only keep price stability - their primary mandate - as the main focus, or whether it will also target a further divergence of bond yields justified by fundamentals in its decisions due to political pressure. Both objectives are difficult to reconcile.”

Further questions may also be asked if proposed new EU debt and spending rules allowing governments greater fiscal leeway are passed, potentially lowering the bar for TPI use, which is currently contingent on compliance with the bloc’s fiscal framework.

“In principle if the rules change, for example the fiscal requirements weaken, then the requirements for a country to get support from the ECB via the TPI also becomes weaker,” Bernoth said.