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ECB Resolved to Face Down Bond Stress Without Divulging Plan

·3 min read

(Bloomberg) -- European Central Bank officials are increasingly determined not to divulge its plans to fight bond-market stress, according to people familiar with the matter.

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Officials from across the spectrum of the Governing Council are convinced that there are few benefits in preemptively revealing a specific crisis tool and fear it could spur investors to test any measure, the people said, asking not to be identified because the discussions are private.

Policy makers have indicated they’d rather wait until a specific threat materializes, in which case there’d be a strong will to act if needed. An ECB spokesperson declined to comment.

Klaas Knot, one of the most hawkish members on the Governing Council, underlined the commitment in an interview published Tuesday in the Le Monde newspaper, saying “it’s clear that our mandate is to respond” if markets threaten the transmission of monetary policy.

Monday saw the yield on Italy’s 10-year debt rise above 4% for the first time since 2014, while the spread over the German equivalent is now at its widest since May 2020.

Those moves follow a selloff last Thursday, when the ECB outlined plans to remove stimulus without sharing further information on a possible new instrument to address market tensions. That intensified this week amid a global rout after data showed the hottest US inflation in four decades.

The market moves in the euro zone suggest investors, who’ve grown used to large-scale bond interventions by the central bank, aren’t fully convinced it can raise rates and keep the bond yields of the region’s most-indebted members in check at the same time.

ECB President Christine Lagarde attempted to counter investor skepticism last week, arguing that the institution has responded quickly to turmoil in the past and is willing to create new tools if needed. For now, policy makers promise to use proceeds from maturing bonds under their pandemic portfolio toward addressing pockets of tension.

The reluctance of officials to show their hand culminates a long debate over tactical considerations on backstops as the ECB begins raising rates for the first time in more than a decade.

Studying Options

In April, Bloomberg reported that ECB staff had started studying options for a crisis tool to deploy in the event of a blowout in the bond yields of weaker euro-zone economies. Policy makers had been discussing announcing a precautionary instrument since as early as last year.

Another reason for holding off on specifics is that publicizing any plan could invite a legal challenge, especially in Germany, where the constitutional court previously questioned whether quantitative easing was proportionate. Meeting that test would be easier if any tool is a response to a specific situation.

A further motivation is that there’s little risk of imminently endangering governments’ debt sustainability, as many euro members have increased the average duration of outstanding bonds -- insulating them somewhat from short-term changes in yields.

At the same time, sovereign bond yields act as a floor on economy-wide borrowing costs, and could result in a disproportionate amount of tightening if spreads widen.

Even so, there’s a risk that any generic new tool may not be sufficiently tailored to the specific situation that it needs to address. An example of such a scenario is 2020, when the ECB unveiled a specially tailored measure to tame bond markets unsettled by the sustainability of weaker euro members’ debt after the onset of the pandemic.

(Updates with Knot comments in fourth paragraph.)

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