by Shaun Richards
Sometimes events come together in a curious way. Regular readers will know that I have used the phrase below to describe my theme on ECB policy.
To Infinity! And Beyond!
Only last week the adverts on Spotify were plugging a new film featuring Buzz Lightyear and this morning the Financial Times has this.
The European Central Bank is this week set to strengthen its commitment to prop up vulnerable eurozone countries’ debt markets if they are hit by a sell-off, as policymakers prepare to raise rates for the first time in more than a decade.
We see that in ECB week ( its policy announcements and statement are due at Thursday lunchtime) it is leaking to its house journal. However there is something of a swerve in this to say the least. As recently as the 25th of May policymaker Fabio Panetta was reinforcing the end of QE.
This is the position of the ECB. We currently intend to end net asset purchases in the third quarter.
This now has morphed into this according to the FT.
The bulk of the 25 governing council members are expected to support a proposal to create a new bond-buying programme if needed to counter borrowing costs for member states, such as Italy, spiralling out of control, according to several people involved in the discussions.
As a first point I remember President Lagarde promising she would stop what has become called “sauces” leaking to the press, whereas it is now rife. So rather than the end of QE bond buying we seem to be following a Churchillian style phase.
Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
Italy
Before the long Jubilee weekend I pointed out this.
Bloomberg’s bond market liquidity index picks up kinks in the yield curve that signal poor liquidity. Those kinks are worse & worse for Italy as we approach ECB hikes ( Robin Brooks)
On Wednesday the ten-year yield for Italy was 3.1% whereas this morning it is 3.36%. Thus ECB fears have been heightened about the Euro area’s largest bond market. This will be added to by the fact that they would not want their previous President presiding over a bond crisis in his present role of Prime Minister of Italy.
There was a link to this in the Fabio Panetta speech for the observant and informed.
First, the size of our balance sheet is already expected to significantly shrink and its composition will change as the TLTROs are wound down, ultimately leading to a reduction of around €2.2 trillion in excess liquidity.
Back when these were enacted the Italian banks took some of this liquidity and invested it in Italian government bonds. This was convenient for the ECB at the time. This merger of credit easing and implied QE has a problem though and we are back to the QE to infinity issue. When it ends the banks will presumably sell the bonds reversing the previous support for the market. If things were better then that is fine but as the quote from Robin Brook’s shows the situation has if anything got worse. Italy as of March had a national debt that nudged over 2.75 trillion Euros.
Back in February BNP Paribas pointed out this.
Italy’s public debt has jumped markedly as a result of the Covid-19 crisis, an increase of around 20 points of GDP over the past two years, which brings the ratio to 150% today. Italy remains the second most indebted country in the euro zone after Greece.
It is revealing that they mention Greece but they are not clear because they mean relatively indebted. The difference as I have pointed out many times over the past decade or so is the size of the Italian national debt which was material back then and is even more material now. Or if you prefer the third largest economy has the largest debt. Covid has made this worse with the extra borrowing and now as we looked at last Wednesday stagflation is on the menu.
Bond Yields
These do get a mention in the FT.
The spread between Germany’s benchmark 10-year bond yield and that of Italy — a closely watched yardstick of financial stress in the eurozone — rose last week to its highest level since a sell-off in southern European bond markets at the start of the pandemic in 2020.
In itself that may simply reflect the fall in ECB QE bond buying but the FT has missed a nuance. You see even Germany is having to pay for its debt now with a ten-year yield of 1.3% as I type this. So the Euro area rescue vehicle called the European Stability Mechanism has to pay too.
The no-grow 1% 23 June 2027 bond
That was from mid May so it would be a fair bit more expensive now. Thus allowing for a margin any support borrowing would be more expensive.
There is a sort of irony as the ECB has to some extent done this to itself.
Many of the council’s hawks have accepted that they will need to provide more support for bond markets to clear the way for being more aggressive in raising rates.
This is because this has so far been a case of open mouth operations as the ECB has not raised interest-rates for over a decade. So what is “more aggressive”? It has tried to manage expectations like this.
A rise of at least 25 basis points is all but certain to happen at the ECB’s next policy meeting on July 21
This is because it is playing Fleetwood Mac on repeat.
I been alone
All the years
So many ways to count the tears
I never change
I never will
I’m so afraid the way I feel
Moving the goalposts
The FT is not covering itself in glory here as it tries to claim this is the central banking equivalent of finding some money down the back of your sofa.
Even without a new scheme, the ECB already has an additional €200bn to spend on purchasing stressed government debt under its existing bond-buying programme. That €200bn would come from bringing forward reinvestments of maturing assets by up to a year.
Whereas it is simply a rather desperate attempt to claim they have 200 billion Euros to spend which rather falls down when you are reinvesting money you do not have yet. This returns us to an issue I pointed out earlier which is that these things rely on a better period coming to which you kick the can ( the poor battered can) except it has yet to arrive.
Comment
This shows a change which will give ECB President Christine Lagarde some food for thought.After all she once thought this.
Lagarde said: ”We are not here to close spreads, this is not the function or the mission of the ECB. There are other tools for that and there are other actors to actually deal with those issues.” ( MarketWatch 12th March 2020)
Which has now become this.
“If necessary, we can design and deploy new instruments to secure monetary policy transmission as we move along the path of policy normalisation, as we have shown on many occasions in the past.”
Sadly for her she is not capable of the Jedi-Mind Tricks of her predecessor Mario Draghi who never had to deploy these.
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above.
As the never happened perhaps the ECB has forgotten what was planned or it was just a mind trick.
After all this you might be wondering why the ECB is doing this? It is simply that it has an expansionary monetary policy with a -0.5% interest-rate and ongoing QE with inflation at 8.1%. So a -8.6% real interest-rate. Added to that President Lagarde’s description of it as a “hump” is not going well.
In April 2022, industrial producer prices rose by 1.2% in the euro area and by 1.3% in the EU, compared with
March 2022, according to estimates from Eurostat, the statistical office of the European Union….In April 2022, compared with April 2021, industrial producer prices increased by 37.2% in the euro area and by 37.0% in the EU.
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