It’s classic ECB to call an emergency meeting six days after a regular meeting to discuss something it has already announced, having lost the thread of its argument around controlling sovereign risk even before its first rate hike of the cycle.
From Bloomberg:
European Central Bank officials will be invited to sign off on the reinvestment of bond purchases conducted under the now-halted pandemic emergency program, a crisis response that they flagged in their decision last week, according to people familiar with the matter.
Policy makers are holding an emergency meeting starting at 11am in Frankfurt that will last about two hours as they consider how to react to a surge in Italian bond yields using the measure, the person said. They declined to be identified because such discussions are confidential.
The people didn’t know if other measures might be considered by the Governing Council.
This is not new? The ECB policy statement on Thursday had explicitly flagged reinvestment of PEPP bonds as a first line of crisis response:
In the event of renewed market fragmentation related to the pandemic, PEPP reinvestments can be adjusted flexibly across time, asset classes and jurisdictions at any time. Net purchases under the PEPP could also be resumed, if necessary, to counter negative shocks related to the pandemic.
A lack of detail about how to address the renewed rise in peripheral spreads provided the disappointment on Thursday. Today’s ad hoc meeting might offer a wider range of possibilities, though none is obviously attractive at the start of a tightening cycle. Here’s Morgan Stanley:
The transmission of monetary policy relies on a clean impulse from rate hikes to borrowing costs in the euro area economy. When the ECB raises rates, borrowing costs should increase in a linear fashion in all euro area countries. If this is not the case, ie, borrowing costs are rising significantly more in some countries than in others, the ECB is faced with a situation of fragmented transmission.
The president and other ECB policy-makers have declared (here and here) that they will not tolerate a fragmented transmission of ECB monetary policy and that they have all tools available to deal with such a situation. In particular, the ECB has stressed the possibility to flexibly use reinvestments under PEPP. Moreover, there have been repeated mentions of a new anti-fragmentation tool.
We see three outcomes as possible going forward:
Verbal intervention: The ECB could simply decide to issue a statement, similar in content to the speech yesterday from Board member Schnabel.
PEPP reinvestments: The ECB could formally decide to activate PEPP reinvestment flexibility and start buying BTPs and Greek bonds. It may also announce a dedicated envelope.
Anti-fragmentation tool: The ECB could decide on a new programme and announce its key features today. The programme would likely only start some days after the announcement.
If fragmentation control really is limited to reinvesting proceeds from PEPP bonds into the periphery, disappointment will redouble. Really, though, what are the options? Morgan Stanley again:
We think that the second scenario is most likely. Only verbal intervention seems insufficient at this stage. At the same time, the bar for enacting a new programme has likely not been reached, as the spread widening seen so far was not systemic. What’s more, PEPP reinvestments have been mentioned many times but so far not actively used, and it would appear likely to us that the ECB first exhausts this tool before embarking on an entirely new programme to control peripheral spreads. In any case, even the full allocation of PEPP reinvestments to peripheral countries would only represent a third of total gross supply. So, while announcing PEPP reinvestments may be enough for today, it’s unlikely to be fully sufficient to counter fragmentation risks.
And here’s SocGen’s Kit Juckes to wax on the ECB’s current bind:
Sometime between the first and second meetings, of the day, as I grabbed a cup of coffee and said good morning to my wife, she said the gods are punishing the ECB for hubris. This is the sort of thing that happens if you marry a classics teacher. The Greek gods didn’t like humans who over-stepped their mark and tried to behave like gods. The ECB’s carefully-communicated strategy was to end asset purchases, then raise rates, starting in small increments and accelerating if needed. That would allow an escape from the current extraordinary policy regime. This strategy is in all sorts of trouble today as the ECB meet to discuss their anti-fragmentation policy and tools.
So far, the euro likes the news, because BTPs like it and as peripheral spreads narrow, the euro can bounce. But the need to prepare the ground to defend the Eurozone bond market highlights the ECB’s dilemma: How can you use monetary policy both to target inflation and to target bond market stability? And how can you stave off fragmentation without easing monetary conditions through additional bond purchases? If the stability of the bond market is more important than the ECB’s inflation mandate, it can stymie monetary policy normalisation, until there’s a fiscal, as opposed to a monetary solution to the euro’s Achilles Heel.
Source: Economy - ft.com
