How will the ECB control debt spreads?
For a few months, the central banks' main dilemma had been to control inflation without damaging growth; however, experts acknowledge that there is now a third component of similar importance: controlling peripheral debt.
The resignation of Mario Draghi as Italian Prime Minister, despite having reversed his decision, has shown how political decisions can have a certain effect on the continent's economy, this time specifically on debt spreads (reaching one-month maximums). The conflict on risk premiums in some of the southern countries of the European Union (including Spain and Italy) has set off alarm bells in recent weeks, and such has been the concern that the European Central Bank (ECB) got to work in June on the design of a new vehicle focused on "discussing current market conditions" and, as a final objective, combating financial fragmentation in the Eurozone.
At its meeting this week, in addition to the anticipated rise in interest rates, the ECB outlined some key aspects of the mechanism to control debt spreads. Alberto Matellán, chief economist at MAPFRE Inversión, believes that the announced program has two possible ways of resolving the situation:
- Printing more liquidity to buy more bonds
- Removing liquidity from particular bonds to facilitate others
In any case, he clarifies that both options would be problematic: “If the first option was applied, they would be doing the opposite of raising rates, which implies draining liquidity, so it wouldn’t make sense. And the second one would generate enormous tension within the ECB due to the comparative harm this would entail.” But in Matellán’s opinion, these measures, beyond the fact that they may be effective in avoiding future debt crises in the region, would serve to buy some time that could be used to raise rates to the ECB’s desired level sooner.
Along the same lines, Ismael García Puente, investment manager and fund selector at MAPFRE Gestión Patrimonial (MGP), points out that he recognizes that this new mechanism raises some doubts within the ECB. “There are numerous members who don’t see it as a good thing. It’s difficult to design a program that convinces all member countries and establishes criteria for buying bonds that benefit some countries more than others.” There is still, from his point of view, a lot of work to do.
Meanwhile, the economy will continue maintaining its focus on the monetary mechanism of the central bankers. The expected rise of 25 basis points (bp) has converted into a more aggressive discussion: The Governing Council decided to raise the three key ECB interest rates by 50 basis points. It thus becomes the first rate hike in eleven years and the largest in 22 years, putting an end to negative rates and ten years of stimulus policies.
Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 0.50%, 0.75% and 0.00% respectively.
As far as Matellán is concerned, the actual amount of the rise is not the core issue: with the deterioration of the latest macroeconomic data, he believes that the important thing now is “to consider how high interest rates will go and how fast they will do so. In this, the ECB has a serious dilemma to consider.