MNI SOURCES: Majority Sufficient For ECB's New TPI Tool

A majority on the Governing Council will be sufficient to activate the European Central Bank’s new Transmission Protection Instrument, with decisions to be based on a varying range of indicators depending on the circumstances, Eurosystem sources told MNI, adding that fallout from fiscally irresponsible policies would not qualify as meriting assistance.

The choice of market metrics to determine whether bond spreads are detached from economic fundamentals and interfering with the transmission of monetary policy will be decided on a case-by-case basis, one official said, noting that consideration of the eligibility for TPI would first depend on the four conditions of financial sustainability set out by the ECB.

But in its press release on Jul. 21, the ECB said the four criteria would only be an “input” into the Governing Council’s decision-making.

“The debt sustainability condition gives a very clear signal of what the ECB's holistic approach looks like,” the source said. “If there is an IMF model, the European Commission has another model, the ESM has another and the national banks others … we will look at them all, and since they are all imperfect, we can learn from each of the different pieces.”

While the Governing Council will seek consensus for any decision, it did not discuss the rules of any vote on whether to deploy its new tool at its meeting last week, nor the precise conditions which would call for its use, other sources said.

AVOIDED DISAGREEMENT

“We discussed and agreed the framework of the TPI, but there are still things we have not yet fully discussed or agreed. In part that is because there was no urgency for an agreement now, but as there was no urgency, there was no need for us to discuss what we were clearly going to find disagreement on,” said one.

The effect of telling markets that TPI has been activated will be key, another source said.

“Maybe they would announce that TPI is activated for country XYZ, and maybe not the amount, or the pace of purchases. Markets get ahead of themselves, and sometimes kind of diminish any monetary policy,” the source said.

The pace of bond purchases could be decided by the Governing Council on the basis of a normal majority, perhaps on a two-weekly or a week-by-week basis, the source noted.

Last week’s meeting decided to give the Governing Council control over whether to activate the tool, after what several sources conceded was horse-trading in return for a 50-basis-point hike rather than the 25 favoured by doves and signalled in the ECB’s own guidance.

Reinvestments of expiring bonds under the Pandemic Emergency Purchase Programme remain the first line of defence against volatility. Countries not deemed deserving of TPI and which were unable to withstand market pressure would have to rely on the Outright Monetary Transactions facility, which requires them to agree a programme with the European Stability Mechanism.

While the TPI will be powerful, it is not equivalent to the “whatever it takes” promised by former ECB president and current Italian prime minister Mario Draghi when announcing OMT in 2012, noted another source. (See MNI INTERVIEW: ECB's Simkus Says New Tool May Never Be Used)

“The main battle was to retain Governing Council discretion,” the source said, referring to last week’s meeting. “This is not whatever it takes because it simply cannot be so – one, we are tightening, and two, Draghi’s statement worked because nobody really cared looking into the details of OMT. Now the emperor is naked.”

ITALIAN ELECTIONS

Irresponsible fiscal behaviour will not warrant deployment of TPI, the source said, pointing to concerns over Italy which is heading for Sept. 25 elections following the implosion of Draghi’s coalition.

“Chaos and lack of direction, commitment are a fundamental reason why markets may sell Italian debt,” the source said. “This would in principle call for not activating the TPI and instead offering OMT as the only way forward or else. That day, if it comes, the ECB will face a genuine Lehman moment.”

The ECB would be unlikely to deploy TPI before a new Italian government is formed, and would not do so later to save it from the consequences of a lack of commitment to fiscal responsibility, another source said.

“We would let the market play and discipline such political promises,” the source said. “We would let the market do its work.”

National credit ratings, while relevant, will not directly affect TPI eligibility, sources said. Sources declined to comment on whether central banks within the eurosystem could be obliged to buy bonds issued by other eurozone countries’ governments.

“Regardless of the answer on whether there will be resharing, it does not affect the effectiveness or power of the instrument,” one source said.