The markets suspect that the ECB’s new tool to deal with bond stress could mimic the old tools.


The ECB on Wednesday promised new support and the design of a potential new device to temper a market rout that has stoked fears of a renewed debt crisis on the southern bank of the euro currency zone.

His statement pushed 10-year borrowing costs in Italy and Greece by up to 40 basis points, the biggest daily change since March 2020 for Greece. In a week when yields across the block hit multi-year highs, the immediate reaction was one of relief.

Yet that was hardly the 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 intelligence to design (a new tool) in a way that is not too strict, keeping flexibility through purchases,” said Patrick Krizan, senior economist at Allianz.

“The biggest mistake would be to be too committed and put yourself in a straitjacket”.

The ECB has already drawn criticism for being too complacent about the risk that its plans to raise interest rates will push the borrowing costs of financially weaker nations like Italy too high relative to those of the Germany, country of refuge.

With the bloc clearly facing this fragmentation problem, it is important that any new ECB bond-buying tool is flexible, investors say.

Thus, like the pandemic-era PEPP emergency stimulus plan, it should abandon the principle of the capital key of buying bonds according to the size of the economies, to buy the debt of the countries that need the most help.

Chart: Italy-Greece-

One of the suggestions is to create a new tool similar to the OMT program (Outright Monetary Transactions), a tool not used in times of crisis allowing the unlimited purchase of a country’s debt.

The main sticking point of the original OMT program is the requirement to underwrite a European Union bailout, often with unpopular conditions.

“The political price is quite high for the current OMT, so the ECB cannot do it 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.

Apart from the budget requirements, “size will be everything, the odds 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 chance bonds.

Another option is to design a policy 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 advantage of the SMP was that it allowed the ECB to buy bonds, without adding to the stimulus measures already present in the system, in a process that economists call sterilization.

For this reason, the governor of the French central bank, Franois Villeroy de Galhau, has declared that bond purchases could once again be part of the sterilization.

The bank could also buy debt during an episode of market stress and then gradually sell when conditions improve, thereby avoiding increasing the overall size of its balance sheet, Villeroy said.

The SMP only had limited success, however, and closed with a value of just €209 billion, shortly after Draghi’s “whatever it takes” pledge in July 2012.

Still, Piet Christiansen, chief analyst at Danske Bank, expects something resembling the SMP.

“Sterilized buying has been our baseline throughout and I think that’s to be expected, because the SMP program was done in such a way as not to interfere with the direction of monetary policy and the only way they could do that is to sterilize the purchases,” he said.

What is certain is that the ECB has the necessary firepower to calm the frenzied markets.

On March 18, 2020, when the COVID-19 outbreak sent Italian/German bond spreads briefly above 300 basis points, the Bank of Italy stepped up its bond purchases on behalf of the ECB. Later that day, the ECB launched its PEPP programme.

Investors urged the ECB to quickly unveil detailed plans, 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, head of investment office Prime Partners.



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