MNI INTERVIEW: TPI A Panic Move ECB Will Lament - Kraemer

The ECB badly overreacted in deciding to launch the Transmission Protection Instrument which will bring unwelcome repercussions, Moritz Kraemer, former head of global ratings at S&P, told MNI.

“I think that the ECB panicked way too early and raised the white flag … It was totally unnecessary, dangerous, and I think it will come back to haunt them,” Kraemer told MNI in an interview.

Kraemer, who is now chief economist at German bank LBBW, said the TPI will disincentivise Italian governments from tackling the root causes of their decades-long economic malaise.

“What this insurance policy, which the Italians now have in their back pocket, does is to weaken their resolve to address core issues … I think that's a real risk, considering the cast of characters running for office in September,” he said.

HAWKS CAGED

Kraemer finds it “remarkable” that hawks on the ECB Governing Council were bought off so cheaply with a 50bp rate hike, while “the instrument (the TPI) - they are stuck with that - will shape policy choices for years to come.”

The ECB would have been better advised to contain spreads using the OMT or by a national TLTRO scheme which would have protected policy transmission to the real economy, he said. Instead they felt that they had to respond to Italy’s wish not to be subject to external control, which was the quid pro quo of Mario Draghi’s OMT in 2012.

Kraemer says it is “inconceivable” that ECB President Christine Lagarde would ever refuse to deploy the TPI. “Markets would say, ‘oh we have been working under the assumption that the ECB would intervene, we’d better get out’, then there would be a sell-off. The day after, Lagarde would have to come back and say, ‘we’re going to do something after all’.”

The fact that the ECB has set no clear rules as to how the TPI will be used, invoked or stopped, makes it an “entirely political instrument”, making it not only hard to manage but also vulnerable to a negative ruling by the German constitutional court.

GERMAN SLUMP LOOMS

Kraemer sees a recession in the euro area next year and a “pretty bad one in Germany,” but suggests the ECB is likely to still raise interest rates to one percent by the end of the year - by 50bp in September and two more hikes before the end of 2022 - before easing next year.

“If we have a real gas-shortage recession then they’ll start cutting again down to zero, which would be highly demoralising for everyone, and would greatly undermine the ECB,” he said (see MNI INTERVIEW: Russia Gas Flow Key To EZ Recession Fear). Kraemer also believes that “social corrosion” and a weakening of political cohesion in Germany is a real risk as the gas crisis starts to hit German pockets. It is an “open question” if workers will ever be able to recover the enormous loss of purchasing power seen in 2022, he says.

While he is not forecasting a house price collapse, or other such ‘Black Swan’ events, he says they cannot be ruled out.

“If we have a complete Russian shutdown, I think it will come to gas rationing and then Germany really is in the eye of the storm because it is dependent on Russian gas and it's also so dependent on industry.”