Exclusive: ECB Insider: Italy at the Moment Is a Classical Situation Where the TPI Should Not Be Used

13 October 2023

By David Barwick – MARRAKECH, Morocco (Econostream) – Rising Italian bond yields due to that country’s higher-than-expected projected budget deficit exemplify the circumstances under which it would be inappropriate for the European Central Bank to deploy its transmission protection instrument (TPI), in the view of a Eurosystem insider who spoke to Econostream recently.

The TPI is intended ‘to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area’, as the ECB said in announcing the instrument in July of last year. The TPI envisions the possibility of securities purchases in countries facing deteriorated financing conditions ‘not warranted by country-specific fundamentals’.

‘Italy right now is exactly the kind of situation where we should not get involved’, this person said. ‘What’s going on is obviously a question of domestic fiscal policy, and it is impossible to claim that it is up to anyone but Italy to take the steps needed to improve market confidence. This is not what the TPI is for.’

Nevertheless, he suggested, the TPI could soon be put to the test in the context of a likely acceleration of the ECB’s quantitative tightening, for which the instrument would provide market cover if needed.

However, even if the ECB certainly needed to consider the possibility that a faster reduction of its balance sheet could have some effect on financial markets, ‘it might not even have all that big an impact anyway’, he said.

After all, he argued, an acceleration of QT would not necessarily represent more than a relatively modest additional tightening that markets could reasonably easily digest.

The ECB would ideally start discussing the pandemic emergency purchase programme (PEPP) at its monetary policy meeting later this month, he said. He did not rule out the possibility that a significant decision would already emerge from the occasion, given the probable lack of other agenda items.

That a potential decision would be implemented immediately was less likely, though he would favour not waiting too long, he said.

Still, he dismissed the argument that the ECB’s credibility could suffer from an abrupt reversal of previous forward guidance on the PEPP. Markets couldn’t really think it made much sense for the ECB to be using the proceeds from maturing PEPP securities to purchase new assets, let alone to be doing so in the context of a programme intended to mitigate the fallout from the pandemic, he reasoned.

Similarly, he said, it was only consistent with the ECB’s overall policy stance to consider the merits of boosting the minimum reserve requirement.

All the same, he said, it was unlikely at this point that any further tightening would take place via the key interest rates. ‘For most of us, the baseline scenario is no further hikes’, he said. ‘Headline inflation should get back to 2% in 2025, unless the unexpected occurs.’

Moreover, he said, the 2026 projection for headline inflation to be released in December, the first forecast beyond 2025, would ‘very probably’ be in line with the ECB’s price stability objective.

All the same, he said, that did not imply any near-term loosening of monetary policy.

‘Yes, the economy could weaken so much that inflation turns out to be lower, opening the door to the possibility of cutting sooner’, he said. ‘But the opposite could also happen. Right now, inflation risks are approximately balanced.’

Developments in terms of inflation have been in line with the projections issued a month ago, while growth had possibly turned out to be even weaker than expected, he said. Higher energy prices and wage pressures meant however that a retreat of inflation could not be taken for granted, he said.

Resistance to rate cuts had to be seen in the context of the ECB’s need to be certain of achieving price stability stably, he said.