MNI INTERVIEW: ECB To Overcome Obstacles To New Crisis Tool

Current spreads between eurozone government bond yields are “quite some way” from levels which could prompt the European Central Bank to take action to rein them in, former director general of ECB market operations told MNI, adding that legal obstacles to the development of a new tool to compress yields are not insuperable.

“Given the difficulty of achieving a consensus in the ECB Governing Council, current spread levels are not sufficient. You have to go quite, quite further before the Governing Council convinces itself it has to do something to fight fragmentation” the senior fellow at the Bruegel thinktank in Brussels said in an interview last week.

The spread between Italian 10-year government debt and benchmark bunds stood at 204 basis points on Monday, just shy of recent highs although up from 115 bps a year ago, but well below the levels around 550 bps seen during the 2012 eurozone crisis. While there have been reports that the ECB is working on a new tool to prevent the fragmentation of the transmission of monetary policy (See MNI SOURCES2:ECB Mulls Crisis Tool As Officials Debate Spreads), Papadia said the ECB is unlikely to spell out the details of any bond-buying plan ahead of time.

“Before it is needed, they will not come with any implementation details,” he said, adding that the ECB would have to justify any assistance, which is likely to be provided on condition the country involved is pursuing “reasonable policies”, both as regards public finance and growth-enhancing structural reforms:

“If a country is already following reasonable policies, then the condition will be `you have to continue with that` – if not, then the condition is `you have to turn to reasonability `.”

NEXTGENEU A MODEL

Criteria applied in the NextGenerationEU programme which has funnelled hundreds of billions of euros to EU governments in the wake of the Covid pandemic with strong conditionality could provide a basis for an assessment from the Commission and the ECB, Papadia said, noting that NGEU has been “very generous to Italy.”

While the ECB has said it could reinvest the proceeds of maturing bonds acquired under its Pandemic Emergency Purchase Programme to contain an excessive blowout in spreads, officials are also reportedly considering a new tool which would be available once PEPP has come to an end. Papadia said officials are likely to be able to overcome the challenge of making such a tool compatible with legal requirements of proportionality, given the ECB’s long experience of implementing such programmes, going back to the Securities Markets Programme of 2010.

“There has been so much back-and-forth with the German Constitutional Court and the European Court of Justice that they know how to present things, not so that it will be impossible for another German legal professor to have a case in front of the GCC, but not enough to really be a hurdle for the ECB,” he said.

Referring to the monetary policy outlook, Papadia said a 50-basis-point increase in interest rates by the ECB could not be ruled out given the way inflation has continued to surprise to the upside.

“Inflation is not only high but always higher than expected and remaining longer with negative rates is controversial,” he said. “I’m starting to think 50 basis points is more likely than I thought until recently. It is not my central view, but I would not say that I put a very low probability on 50 basis points.”