Bond jerks hit Italy as Eurozone risk returns with a vengeance
The northern ECB hawks are ready to fight. Austrian Governor Robert Holzmann is calling for three rate hikes this year. It’s the same refrain from Finland and the Netherlands.
Isabel Schnabel, a German member of the executive board and political spokesperson, suddenly switched sides. “We need to prevent high inflation from taking root in expectations. Talking is not enough anymore, we have to act,” she told the Handelsblatt in a fire-breathing interview last week.
She talked about ending all QE asset purchases by the end of June and suggested a rate hike – of minus 0.5% – as early as July. The warning to the markets could not be clearer.
The ECB believes it can continue to protect Italy no matter what, mainly by shifting ever more of its existing portfolio into Italian debt as old bonds expire.
But that means accumulating most of Italy’s public debt over time. It comes up against serious technical, legal and political limitations. HSBC’s Fabio Balboni said markets are likely to “test” this defence.
ECB staff have been working on another anti-spread weapon for months, but this one has yet to see the light of day, likely because it violates the Lisbon Treaty’s no-lease clause. The project will inevitably be challenged before the German Constitutional Court.
If all else fails, there is one last “nuclear option” to support Italy’s debt. It was designed by Mr. Draghi himself when he headed the ECB ten years ago.
It is made up of loans from the EU rescue fund (ESM), which can then trigger targeted bond purchases by the ECB as an accompanying measure. But the rescue plan requires the approval of the German Bundestag and other parliaments. The conditions would be draconian.
The instrument has not yet been ratified in Rome due to resistance from the political right. A Fratelli-Lega coalition would be reluctant to activate the process until Italy is on the verge of default. By then, the contagion spreading through Spain, Portugal and the rest of Club Med could risk replaying the debt crisis of 2011.
In a sense, Italy has been in suspended political animation since 2018, when voters elected left and right anti-euro parties in an overriding cry against the status quo.
The set up poteri forti found ways to tweak this over time, eventually installing a technocratic government more to their liking under the quintessential Mr. Euro, with no elections along the way to legitimize this 180 degree reversal. They have not yet found a way to completely abolish the vote.
Italian political risk is back on the table, just as the ECB’s debt shield disappears.