Analysis-Markets suspect ECB’s new tool to deal with bond stress could mimic old tools By Reuters
© Reuters. FILE PHOTO: The European Central Bank (ECB) headquarters building is seen in Frankfurt, Germany March 7, 2018. REUTERS/Ralph Orlowski/
By Yoruk Bahceli and Dhara Ranasinghe
LONDON (Reuters) – Rather than invent a radical new instrument to ease tensions in bond markets across the euro bloc, investors believe the European Central Bank could get away with cooking up the best bits of programs already contained in its policy toolbox.
The ECB on Wednesday pledged fresh support and the design of a potential new plan to temper a market rout that has stoked fears of a renewed debt crisis on the eurozone’s southern shore.
His statement sent 10-year borrowing costs in Italy and Greece down by as much as 40 basis points, the biggest daily move since March 2020 for the latter. In a week when yields across the bloc hit multi-year highs, the immediate reaction was relief.
Yet that was hardly the all-rights promise that former ECB President Mario Draghi made almost exactly ten years ago, signaling his determination to save the euro from collapse.
“I hope they will have the smarts to design (a new tool) in a way that is not too strict, keeping flexibility through purchases,” said Patrick Krizan, senior economist at Allianz (ETR: ).
“The biggest mistake would be to be too committed and put yourself in a straightjacket.”
The ECB has already been criticized for being too complacent about the risk that its plans to hike interest rates will push borrowing costs for financially weaker countries like Italy too far above those of the EU. Germany refuge.
With the bloc clearly facing this fragmentation problem, it is important that any new ECB bond-buying tool is flexible, investors said.
So, much like the pandemic-era PEPP emergency stimulus program, it should abandon the all-important principle of buying bonds based on the size of economies, instead of buying the debt of countries that have need the most help.
One suggestion is to create a new tool similar to the system of monetary transactions in securities (OMT), a tool unused in times of crisis allowing unlimited purchases of a country’s debt.
The main sticking point of the original OMT program is the obligation to subscribe to a European Union bailout, often with unpopular conditions.
“The political price is quite high for the current OMT, so the ECB cannot do this alone, there must be something on the political side to design an OMT-light, which allows a country to be a little protected,” Krizan said.
Analysts said they would expect an OMT-like program to come with strings attached, but not as stringent as the original program.
Besides the tax requirements, “size will be everything, the maturities of the bonds they will be looking at, those are the most important,” said Antoine Bouvet, senior rates strategist at ING Bank.
The original OMT program focused on buying shorter term bonds.
Yet another option is to design a package with the characteristics of the precursor to the OMT – the Securities Markets Program (SMP), which did not include the strict and formal conditionality of the OMT.
The silver lining of the SMP is that it also allowed the ECB to buy bonds, without adding to the stimulus already underway in the system, in a process economists call sterilization.
For this reason, the Governor of the French Central Bank, François Villeroy de Galhau, said that bond purchases could again be sterilized.
The bank could also buy debt during an episode of market stress and then gradually sell back as conditions improve, thereby avoiding increasing the overall size of its balance sheet, Villeroy said.
The SMP had limited success, however, and was terminated with a value of just €209 billion, shortly after Draghi’s July 2012 pledge “whatever it takes”.
Still, Piet Christiansen, chief analyst at Danske Bank, expects something along the lines of the SMP.
“Sterilized purchases have always been our baseline and I think that is to be expected, as the SMP program was designed in such a way as not to interfere with the monetary policy stance and the only way to do that is to sterilize purchases,” he said.
What is certain is that the ECB has the firepower to calm frantic markets.
On March 18, 2020, when the COVID-19 outbreak briefly pushed Italian/German bond spreads above 300 basis points, the Bank of Italy stepped up its bond purchases on behalf of the ECB . Later in the day, the ECB launched its PEPP program.
Investors urged the ECB to unveil detailed plans soon, warning that otherwise the relief in the bond market would fade.
“At the end of the day, people want to see action,” said Francois Savary, director of investment office Prime Partners.