Bundesbank boss warns of ‘fatal’ assumptions in ECB crisis tool

The head of the German Bundesbank has warned that it will be “virtually impossible” to decide whether a difference in borrowing costs between eurozone countries is justified, arguing that it would be “fatal” for governments to rely on the support of to trust the European Central Bank.

Joachim Nagel’s comments in a speech on Monday were the first sign of serious disagreement at the ECB over its plan to develop a new asset purchase tool to avoid an “unwarranted” rise in bond yields from more vulnerable groups. countries as soon as it starts raising interest rates.

Nagel said that “it would be fatal for governments to assume that the Eurosystem will eventually be ready to ensure favorable financing conditions for member states”, and that interest setters could legally find themselves in “difficult circumstances” because of the instrument.

The comments from the chief of Germany’s central bank reflect growing concerns among the more stable northern European countries that the ECB risks exceeding its target of keeping bond yields low for more indebted southern member states. Some policymakers worry that failure to encourage governments to rein in spending could undermine the ECB’s efforts to tackle high inflation.

Since the ECB announced plans to hike rates this month, bond yields in weaker countries like Italy have risen faster than those in more stable countries like Germany, prompting it to start work on a “new anti-fragmentation tool”. speed up.

It is against EU law for the central bank to finance governments and Nagel said the ECB should put in place sufficient safeguards to prevent it from drifting into “monetary financing”.

The central bank has defended its past bond purchases against numerous legal challenges in Germany, but this could be more difficult now without the justification for fighting under-inflation.

The ECB is concerned that a panic in the bond markets could push the borrowing costs of weaker countries up to levels that plunge them into a financial crisis. It believes that a new tool to counter this risk is warranted, as it would maintain its ability to propagate monetary policy equally to all 19 members of the single currency bloc.

The difference, or spread, between the German government’s 10-year borrowing costs and Italy’s has doubled from 1 percentage point a year ago to about 2 percentage points in recent weeks.

However, Nagel warned against “using monetary policy tools to limit risk premiums, as it is virtually impossible to determine with certainty whether or not a wider spread is fundamentally justified”.

“It is easy to find yourself in great difficulty,” he said, adding “it is clear that unusual monetary policy measures to counter fragmentation can only be justified in exceptional circumstances and under narrowly defined conditions”.

Since Nagel took over from the Bundesbank early this year, he has become increasingly concerned as inflation in the eurozone has risen to a record level of 8.6 percent. He said the ECB, of which he is a member of the Governing Council, “must focus all our efforts on fighting this high level of inflation”.

The German central banker has set out a number of parameters for any new ECB instrument, including that it must be “strictly temporary” and designed so as not to hinder its efforts to bring inflation back to its target. He added that it should provide governments with “sufficient incentives” to reach sustainable debt levels.

Such an instrument should be “based on comprehensive and regular analysis covering a broad range of indicators” and only be used when interest rate spreads “are the result of excesses in the financial markets,” he added.

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