ECB Insight: Schnabel Sounds Tough on Fragmentation, But Words May Not Be Enough

15 June 2022

By David Barwick – PARIS (Econostream) – As determined as European Central Bank Executive Board member Isabel Schnabel is to prevent fragmentation from derailing the ECB’s incipient policy normalisation, it is considerably more questionable whether her verbal intervention on Tuesday evening will achieve the desired effect on any sustained basis.

One of the problems is that the markets have heard it all before – including that ‘the ECB is ready to do whatever it takes’ (the Mario Draghi version) and that ‘there are no limits to our commitment to the euro’ (the Christine Lagarde version, heard most recently - though not for the first time - on May 11).

Repetition in the context of an anti-fragmentation tool extends beyond any single catchphrase. Consider what Banque de France Governor François Villeroy de Galhau said just last Friday:

‘…fragmentation is the excessive and unjustified rate differentials between the countries of the Eurozone, which hinder the proper transmission of monetary policy. …we have always been able to combat this fragmentation. In 2010, in 2012, in 2020, each time with different instruments. …it was called the SMP in 2010, the OMT in 2012, the PEPP in 2020. … We have the will, and no one should have any doubt that we will have the instruments if and when necessary. I want to say this very clearly. … I reminded you of the history. Each time, we have found the appropriate instruments when and if necessary to deal with situations of tension.’

While there is no need to reproduce all the details of both interventions, Villeroy in effect summed up in one paragraph the essence of Schnabel’s speech four days before she gave it.

Had Schnabel come bearing gifts, that would be another story. Unwrap the words, though, and there isn’t anything terribly new to be found. ‘Our commitment to the euro is our anti-fragmentation tool’, she said.

What? She might just as easily have been up front about the fact that, quite a few months into this discussion, the ECB still has no new anti-fragmentation tool and is not close enough to having one to do more than rehash already well-seasoned talking points.

Admittedly, Schnabel didn’t exclude the possibility of new tools, asserting that ‘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.’

But that’s what Villeroy said, and he was hardly the first. It is the language many observers, ourselves included (as discussed here at length on April 13 and again on May 27), have suspected for some time the ECB would resort to in lieu of anything more substantive.

In effect, the ECB must overcome the overarching problem that ECB officials have themselves sowed doubts on repeated occasions about the need for and desirability of such a tool at all. For example, Bundesbank President Joachim Nagel on May 14 said that ‘[f]rom today's perspective, I can see that we don't have a problem there yet…’

And ECB Chief Economist Philip Lane on February 23, while assuring that flexible PEPP reinvestment ‘can help with any fragmentation risk that might arise’, also suggested that ‘the situation is in any case completely different to that in the financial crisis 13 years ago. ... Should interest rates move up from a very low level to a slightly higher one, the consequences would not be comparable to what we saw then.’

That’s not to pick on either Nagel or Lane – other examples could be found - or to overlook the fact that the situation can change. Indeed, if nothing else, Schnabel’s speech on Tuesday seems likely to represent a growing perception within the Eurotower that the potential for a problem – never overlooked, we readily acknowledge – may be materialising.

If it does materialise full-bore, then we don’t find it all that hard to believe Schnabel's affirmation that the ECB will in fact do whatever it takes and in particular if pushed enough by markets will eventually shove back. But at this point, just sounding tough may not be enough to stop them from testing the ECB’s resolve.