Why Lagarde Italy’s new market intervention tool may not help


The European Central Bank has provided details of its latest bond-buying intervention mechanism to ensure its first tightening cycle in more than a decade does not cause increased stress in the bloc’s debt markets.

But investors hoping the program will be deployed quickly to prop up Italian assets amid fresh political unrest in Rome may be disappointed, analysts say.

“The new tool … will only be used sparingly as a backstop and only at much higher spreads than we are currently seeing,” said Jens Eisenschmidt, Morgan Stanley’s chief economist for Europe.

The new Transmission Protection Instrument (TPI) “is necessary to support the effective transmission of monetary policy,” the ECB said. “In particular, as the Governing Council continues to normalize monetary policy, the TPI will ensure that the monetary policy stance is smoothly transmitted to all euro area countries.”

The move towards “normalization” accelerated on Thursday as the ECB hiked borrowing costs 50 basis points more than forecast to zero percent to combat record inflation in the euro zone, which currently stands at 8.6%.

Highly indebted countries like Italy and Greece have already seen government bond yields rise in anticipation of monetary tightening in recent months. However, ECB President Christine Lagarde is concerned that yields could exceed levels warranted by economic conditions, potentially leading to another eurozone debt crisis and risking fragmentation of the bloc.

“Subject to meeting specified criteria, the Eurosystem will be able to make secondary market purchases of securities issued in countries where financing conditions are deteriorating, which is not justified by country-specific fundamentals,” the ECB said.

No limits have been placed on the program, with the extent of purchases depending on the severity of the risks faced by monetary policy transmission, the ECB said. Bonds with maturities between 1 and 10 years issued by central and regional governments would be eligible for purchase, although private sector securities “may be considered as appropriate”.

More budget-conscious eurozone members like Germany and the Netherlands have long argued that such largesse from the ECB only encourages fiscal inertia, and their concerns may be eased somewhat by the four criteria required for countries to be eligible for the aid.

These are: compliance with the EU budgetary framework; absence of serious macroeconomic imbalances; fiscal sustainability; and sound and sustainable macroeconomic policies in line with the European Commission’s country-specific recommendations.

Source: FactSet

On Friday, traders resumed dumping of Italian bonds TMBMKIT-10Y,
after the resignation of Prime Minister Mario Draghi triggered parliamentary elections in September, fears of further political unrest in the heavily indebted euro area were fueled.

The benchmark for German government bonds is TMBMKDE-10Y,
The spread between Italy and Germany widened to 230 basis points after surveys showed the continent’s largest economy was shrinking, signaling concerns Draghi’s departure would hamper economic reforms aimed at boosting Italy’s long-term growth.

But the TPI is unlikely to come to the rescue, said Mark Wall, chief economist at Deutsche Bank.

“As expected, the tool cannot intervene to counter country-specific fundamentals, for example due to changes in fiscal policy. Therefore, there was no indication that the ECB would introduce TPIs to deal with the recent pressure on BTPs [Italian government bonds] Given the political uncertainties in Italy,” Wall said.

Reinhard Cluse, economist at UBS, noted that the ECB has announced that it will halt asset purchases if there is “a sustained improvement in transmission or on the basis of an assessment that the ongoing tensions are due to country fundamentals.” .

“We believe that the latter phrasing is a nod to countries like Italy, which is at least partly due to political or other domestic reasons,” Cluse said.


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