ECB/EU bonds: big bazooka needed to stop spreads blowing up
To QE or not to QE? That is the question. The European Central Bank made it clear at its emergency meeting last week that it would seek a new tool to control euro-zone government bond spreads. Rising inflation and the promise of higher interest rates are just two hurdles in the way of a new quantitative easing program and the continuation of the “Draghi put” on European debt.
So far, the market is playing along. Interest rates on Italian debt are back below levels that sparked panic. But as the ECB pushes through its first rate hike in more than a decade, pressure on peripheral debt will increase again. It means tightening through rate hikes and selective easing to avoid “fragmentation”. To be successful, the next step in the European monetary and political experiment must be more radical than the previous one.
What the ECB will do is reinvest in existing maturities of its Pandemic Emergency Purchase Program (PEPP). At about €15 billion to €20 billion per month, this would be well below historical bond purchases of up to €80 billion per month. It could choose to do the same with public sector purchasing program (PSPP) maturities, which would roughly double monthly purchases.
Another option would be to sell holdings of German and French government bonds and buy peripheral debt.
Critics would note this as a further step towards monetary financing of government deficits. It would be open to legal challenge.
Sterilization of bond buying could also be attempted, with countermeasures negating any expansion in the money supply. For this purpose, higher deposit requirements were applied in 2010 in the relatively small securities markets programme.
What the market really wants is another “whatever it takes” moment, calling on Mario Draghi’s 2012 commitment to keep the euro. The basis for this was outright monetary transactions, a bottomless bond-buying program that bolstered confidence in the euro without ever having to be used.
ECB dithering only serves to prolong the amount of time — and the pain — before another bazooka becomes inevitable.