ECB’s Schnabel: Our Commitment to the Euro is our Anti-Fragmentation Tool and Has No Limits

14 June 2022

By David Barwick – PARIS (Econostream) – The European Central Bank’s unlimited commitment to the euro implies that fragmentation will not be allowed to hamper monetary policy transmission, ECB Executive Board member Isabel Schnabel said Tuesday.

The ECB can and should counter a disorderly repricing of risk premia if this interferes with the transmission mechanism, and is watching current market developments closely, she said in a speech at the Sorbonne.

The ECB reaffirmed last December its commitment to prevent price adjustments inconsistent with the smooth transmission of its monetary policy, she reminded. In this context, she noted, the ECB would make use of flexibility and could do so ‘within a very short period of time if we conclude that policy transmission is at risk.’

This commitment was ‘stronger than any specific instrument’ such as the PEPP, she said. ‘Our commitment to the euro is our anti-fragmentation tool. This commitment has no limits. And our track record of stepping in when needed backs up this commitment.’

ECB action depends on the precise circumstances, but the Eurotower’s track record confirms its ability to react flexibly and without delay, she said.

‘We will react to new emergencies with existing and potentially new tools’, she said. ‘These tools might again look different, with different conditions, duration and safeguards to remain firmly within our mandate. But there can be no doubt that, if and when needed, we can and will design and deploy new instruments to secure monetary policy transmission and hence our primary mandate of price stability.’

Upward pressure now being seen on bond yields in the wake of reduced monetary accommodation could be attenuated to a degree by the delay with which higher borrowing costs will pass through to sovereigns’ total debt burden after years of low interest rates; by the fiscal impact of the Next Generation EU recovery fund; and by ongoing strengthening of monetary union’s framework, she said.

Still, she continued, the withdrawal of monetary support is occurring in the context of ‘challenging economic circumstances’ in which growth and investment have been subject to one shock after another. ‘Risks of a destabilisation of inflation expectations substantially deteriorate the trade-off facing monetary policy’, she said.

Worries about how much tighter monetary policy needs to be to check inflation have mounted recently, a trend reflected in higher sovereign risk premia and other market developments, she said. This means that changes in financing conditions have varied considerably across sovereigns, she said.

‘Such changes in financing conditions may constitute an impairment in the transmission of monetary policy that requires close monitoring’, she said. ‘What is important in this environment is that investors have a clear understanding that monetary policy can and should respond to a disorderly repricing of risk premia that impairs the transmission of monetary policy and poses a threat to price stability.’

Schnabel conceded that the yields applicable to different sovereigns are not automatically the same, given that investors naturally assess the riskiness of countries differently.

Variations in sovereign yields and between financial instruments whose pricing is a function of these are normally of less concern, but over time can lead to a disparity between the risk-free rate and national financing conditions that is the responsibility of governments, she said.

When such variations cease to reflect economic fundamentals, whether related to the availability of liquidity, elevated uncertainty or other reasons, instability can result, she said. The construction of the euro area renders it potentially particularly vulnerable to such developments, she said.

Rules like those enshrined in the Stability and Growth Pact have historically been inadequate as a shield against developments threatening the foundations monetary union, she said.