Exclusive: ECB Anti-Spreads Programme to Face Bumpy Path, Econostream Understands

13 April 2022

By David Barwick – FRANKFURT (Econostream) – Although European Central Bank President Christine Lagarde is likely to be reticent on Thursday about the programme the Eurotower is working on to keep sovereign spreads in check, the facility may face a rocky road when it comes to internal approval, Econostream understands.

The instrument, currently still very much in the design stage, is motivated by the desire to protect more heavily indebted euro area member states from pressure they might come under on debt markets, and would clearly involve support in the form of sovereign debt purchases.

The timing of the idea is no coincidence. The ECB regards increasingly inevitable rate hikes – to say nothing of the quantitative tightening that will one day follow - with some reluctance, based on what an ECB insider who spoke to Econostream called fears in some jurisdictions that a tightening cycle could trigger tensions on their sovereign bond markets.

This, the person said explicitly, explained the high support in some quarters for a new facility that could buy bonds to counter such tensions if needed.

That the ECB is still a good way off from being able to communicate details is not unrelated to the fact that such a programme, far from being just another Eurosystem facility, could potentially call into question the institutional setup of the Eurozone.

The insider Econostream spoke to expressed in particular the concern that a permanent, unconditional means of reacting to market stress would in effect introduce via the backdoor a transfer union, something that the region’s elected authorities have not been ready to embrace.

From a legal perspective, this person said, this would be highly dubious and probably not in line with the EU Treaty. The more likely outcome of the ECB’s efforts is thus a backstop intended for strictly transitory deployment, conceivably as a bridge leading to the ECB’s Outright Monetary Transactions (OMT) programme, under which the ECB would buy sovereign debt on secondary markets and under strict conditionality.

Whilst one could ask why the OMT was not already sufficient, an even better question, he pointed out, would be why the precautionary financial assistance already available via the European Stability Mechanism (ESM) was not enough, given the latter is less stringent about conditions than the OMT.

However, he noted, there are many divergent perspectives on the entire issue, and some Governing Council members naturally view favourably the ability of the ECB to buy, in the style of the pandemic emergency purchase programme (PEPP), Italian or Greek bonds in relatively arbitrary volumes and without having to worry too much about the ECB’s capital key.

Still, he insisted, a permanent mechanism under which the ECB automatically buys bonds when someone doesn’t like a given increase in spreads is a less probable result than a facility targeted to crisis situations.

The experience of various countries going through the exchange rate mechanism en route to euro area membership offered useful lessons, he noted. In ERM, in which forex intervention is part and parcel of fulfilling membership conditions, the ideal interventions are not in response to levels, but rather to the speed with which changes occur.

The programme being designed by the ECB would thus probably define some magnitude of change in spreads as a crisis situation warranting a response, rather than targeting levels; the latter would require that someone grapple with the thornier question of what level is justified by fundamentals and what level is not.

Any programme appearing to target spreads is still going to be called into question, as spreads have little to do with the inflation outlook that is the ECB’s singular mandate, he said. But if it is understood that the programme would be activated only in the event of market turbulence, then that would improve its chances both within the ECB and in the context of legal challenges likely to follow, he said.