The European Central Bank unveiled a new Transmission Protection Instrument (TPI) for its monetary policy in response to the recent turmoil in euro area sovereign debt markets, on Thursday 21 July in Frankfurt, the day that Mario Draghi’s Italian coalition government fell in Rome due to a lack of parliamentary support, prompting the call for early parliamentary elections on Sunday 25 September.
Complementing the arsenal of unconventional measures that the monetary institute has acquired over the years (‘OMT’ and ‘PEPP’ operations), this instrument will enable it to acquire securities with a maturity of between 3 and 10 years issued by treasuries, regional authorities and public agencies belonging to a euro area country.
It is a demonstration of the ECB’s determination not to allow a new public debt crisis to erupt in the euro area while macroeconomic uncertainties remain very high due to an economy that has been tested by the Covid-19 pandemic and affected by the inflationary repercussions of the Russian invasion of Ukraine.
On Friday, the 10-year interest rate on Italian securities was down to less than 3.4%, although the decline was less than that seen on the securities of other euro area countries.
For the ECB President Christine Lagarde, the IPT will, if necessary, ensure that the monetary policy stance is transmitted “smoothly” across all euro area countries and can be activated to counter any “unwarranted and disorderly” market dynamics that appear in the financial markets.
There is no “ex ante limit” to this instrument approved “unanimously” by the governors, she warned, with the size of the purchases depending on the level of risks to the transmission of monetary policy. And while it would prefer not to have to activate it, the Governing Council “will not hesitate” to do so if necessary and will act “vigorously”and “at any point in time”, she assured.
Ms Lagarde outlined four indicative cumulative fiscal and macroeconomic criteria that the Governing Council will take into account when deciding to activate the IPT. To be a beneficiary, a euro area country will have to respect the European economic governance framework, notably by not being subject to an excessive deficit procedure. It should not have excessive macroeconomic imbalances. The trajectory of its public debt will have to be sustainable. Its budgetary and economic policies will have to be in line with the commitments made in its recovery plan supported by the Next Generation EU Recovery Plan and it will have to comply with the country-specific recommendations addressed to it in the framework of the ‘European Semester’ fiscal process.
The Governing Council will take these four criteria into account, but it also has a “margin of discretion” to decide whether to activate the IPT instrument, in particular to ensure that the scale of purchases remains “proportionate” to the ECB’s mission to fight inflation, Ms Lagarde argued. She did not deny that some elements of the instrument remain secret.
In any event, reinvesting the amounts resulting from the redemption of maturing securities acquired via the ‘PEPP’ triggered to counter the pandemic is the ECB's first line of defence against the risks of inappropriate monetary policy transmission.
For more information on the TPI instrument: https://aeur.eu/f/2ps
Surprise 50 basis point increase in key interest rates
On Thursday, for the first time in more than a decade, the Governing Council also decided to raise the ECB’s three key interest rates. And it surprised by announcing a 50 basis point increase, whereas a 0.25% increase had been envisaged in June (see EUROPE 12968/1).
As from Wednesday 27 July, the interest rates on the main refinancing operations, the marginal lending facility and the deposit facility will be raised to 0.50%, 0.75% and 0.00% respectively.
The ECB said it was more appropriate to do so because upside risks to inflation had materialised since its Amsterdam meeting, notably because of a depreciation of the euro against the US dollar and because of the creation of the IPT instrument, Lagarde said. For the ECB, taking the monetary institute out of negative territory now will allow the it to specify its path for normalising key rates in advance at each Governing Council meeting and on the basis of updated macroeconomic data. But the former IMF director declined to say what the appropriate rate level would be.
Describing the macroeconomic situation, Ms Lagarde noted an accumulation of risks to economic activity caused by the Russian invasion of Ukraine: inflation remaining “undesirably high” (euro area average of 8.6% in June) which is spreading to “more and more” sectors of activity, and supply failing to keep pace with demand.
“These factors significantly cloud the outlook for the second half of 2022 and beyond”, Ms Lagarde acknowledged, noting also that banks, in response to the ECB’s rate hike, are passing on the increase in the cost of money to their retail and corporate customers.
However, it noted other factors supporting the economy, such as robust consumption, very low unemployment, fiscal policies that provide targeted support to troubled sectors and contained wage growth.
See the monetary policy decisions: https://aeur.eu/f/2px (Original version in French by Mathieu Bion)