Agreeing on conditions for the ECB's planned new anti-fragmentation tool won't be easy, sources say.
(Repeats article first published on June 30)
European Central Bank officials are likely to consider a range of possible new tools to address any blowout in eurozone spreads at its next meeting on July 21, with debate on committees now preparing the proposals focussing on how to make countries requiring assistance pledge to improve their finances and on how long bond purchases could continue, central bank sources told MNI.
While the ECB has said it will use reinvestments from its Pandemic Emergency Purchase Programme to cap spreads if necessary, officials acknowledged that a new tool with greater firepower could be necessary if the government bonds of a country like Italy were to come under sustained pressure.
But while any such tool would have to come with strict conditions in order to withstand possible scrutiny from Germany’s constitutional court, the nature of these will be difficult to agree, with Italy’s government in particular bridling at the requirements imposed by the ECB’s existing facilities such as Outright Monetary Transactions. (See MNI SOURCES2:ECB Mulls Crisis Tool As Officials Debate Spreads)
Possibilities include conditioning use of the tool to targets agreed by member states to access the European Union’s EUR723.8 billion Recovery and Resilience Facility, though that would be complicated by the fact that assessments are carried out only annually. Alternatively, tying it to the Excessive Debt Procedure could also be possible, one Eurosystem source said, adding that he expected up to three proposals from the Committees for tools aimed at preventing fragmentation of monetary policy transmission, even if only one is presented to the Governing Council.
The other key conditionality is likely to be duration, the source, adding that approval for a tool may only come if it is time-limited. Agreement could require more than one meeting, the source said.
There is also debate over whether the conditions for the tool should be made public, another source said.
Any tool would only serve as a backstop after all else has failed, the source said, adding that there was significant divergence within the Governing Council regarding the conditions under which such a tool could be deployed, and that any decision on these would be likely to be fudged or put off until later.
Another source agreed that conditionality, likely be linked to a medium-term fiscal sustainability programme, will be crucial in gaining approval for a new tool.
Several sources agreed that the PEPP reinvestments, which ECB President Christine Lagarde has said can be flexibly deployed from as soon as Friday to cap spreads, would be the tool of first resort, even though they could be overwhelmed in a crisis.
“PEPP reinvestments don’t have much firepower, their effect will therefore be quite limited,” one official said. “The new tool - whatever it is, and there is a broad outline - will be the real backstop. With that in place, the monetary policy stance can be much more focused on ensuring price stability.”
The new tool will be a “bazooka” which hopefully goes unused, one of the sources said. Although, as is the case with the PEPP, the new tool may not be constrained by the “capital key” capping purchases of individual countries’ bonds under the ECB’s older Asset Purchase Programme, it would not be practically possible to direct all of the new tool's reinvestment firepower only at debt suffering from market attack.
While the ECB’s rate hikes flagged for July and September are not reliant on having a new backstop in place, this could allow a faster pace of rate hikes should that become necessary, a source said, adding that proposals to sterilise bond purchases under the tool were more of a “presentational” issue than something of real market significance.
In the meantime, as the ECB prepares to tighten, there are already signs that the economy is weakening, one of the sources said, adding that inflation could already be close to peaking and that the threat of a U.S. recession was rising.
An ECB spokesperson declined to comment on the matter.