ECB uses emergency meeting to get back on the front foot
It is never ideal for a central bank to hold an emergency meeting; the very fact is prone to cause nervousness in financial markets. As it was, the European Central Bank seems to have been able to use its “ad hoc” meeting Wednesday morning to get somewhat back on the front foot after being caught out by market reactions to its monetary policy meeting the week before.
That meeting came as investors had started to worry about how the ECB’s move towards tightening financial conditions would affect the borrowing costs of the fiscally weaker eurozone governments. Their disappointed hopes of a stronger commitment to contain widening sovereign spreads caused steep sell-offs: in less than a week, Italy’s borrowing costs rose by almost one percentage point.
It was the speed of this change that forced the ECB’s hand. The past week has brought back chilling echoes of the eurozone sovereign debt crisis. Apart from the sudden widening of yield spreads, the analyst community is full of chatter about “fragmentation risk”. Conditions have quickly become ripe for speculative attacks on pressured sovereigns’ debt and a repeat of the ugly politics of creditor-debtor country antagonism.
This is what the ECB had to arrest, having failed to foresee the rapid deterioration that its own earlier circumspection had caused. The terse statement from the emergency meeting is short, but should not leave any doubt that the bank has moved into a new phase.
The meeting did three important things. First, the ECB now explicitly states that its monetary policy is in fact being unevenly transmitted to different member countries — its code for intervention in bond markets being justified. Second, it has moved from communicating the possibility of using its balance sheet reinvestments to combat excessive spreads to an express intention of doing so. And third, a new “anti-fragmentation” tool, mooted as an if-necessary resort for months, has now been ordered up from the technical staff.
Early signs are that the more robust approach is working; yields and spreads have come down from the most recent heights. Whether it is enough is anyone’s guess, but the track has now been laid for several forms of intervention to come within weeks or months.
Above all, this highlights the differences from the previous crisis. The ECB is now clearly in the game of containing spreads and, as important, its governing council is reasonably united behind this understanding. We are no longer in the world where former president Mario Draghi had to bounce his colleagues into action through dramatic unilateral “whatever it takes” statements. There is no doubt that the ECB has the means to prevent a fragmentation crisis; and the bank is finally working hard to dispel any doubts that it has the will.