Deutsche Bank: Why the ECB can not yet activate a new support program

Of Eleftheria Kourtali

It should come as no surprise that the ECB has not announced or provided details on a possible new program to support the bond market, as Deutsche Bank points out and explains why the central bank has not yet been able to do so, although it estimates that sooner or later he will be “forced” to activate it. At the same time, the German bank sees interest rates at 1% by the end of 2022 and at 2% in June 2023.

According to Deutsche Bank, the FT on Monday referred to the possibility of a stronger statement by the Board of Directors about the intention to create a new anti-fragmentation tool in the June monetary policy statement. Ultimately, the wording of the statement remained unchanged, committed to flexibility and combating fragmentation, and indirectly mentioned, not directly, the possibility of a new tool with new tools.

However, in the press conference, Christine Lagarde strongly emphasized her previous references to the ECB’s commitment to avoiding fragmentation as well as the ECB’s expertise in designing and developing such tools – “it has done so in the past and is willing to do so. does it again in the future “- especially if fragmentation threatens to undermine the central bank’s ability to achieve its mandate for price stability.

The market remains frustrated and nervous about the lack of a precautionary tool and yields on 10-year Italian bonds rose 20-25 basis points to 3.60% after the June monetary policy statement.

However, the lack of news about this should not come as a surprise, Deutsche Bank emphasizes.

First, the ECB made the PEPP reinvestment program more flexible as a first line of defense against fragmentation. These are multifaceted flexibilities, allowing the ECB to adjust PEPP reinvestments “over time, asset classes and jurisdictions at all times”. In a sense, this flexibility must prove insufficient for a new tool to emerge, and Lagarde seemed to place more emphasis on the role that PEPP can play in combating fragmentation in the press conference.

Secondly, as the German bank adds, we know from the latest ruling of the German Constitutional Court in 2020 that the new tools of the ECB must be proportionate in order to be legally sound. It is easier to create an analog tool in response to a problem than in advance. Thus, by delaying, the ECB will be less restricted by the Court.

The only thing the ECB can do in advance, as Deutsche Bank points out, is to communicate as strongly as possible its willingness and ability to create a new tool to tackle fragmentation, if necessary. This is what the ECB does.

The absence of a tool so far is not an indication that it is less likely to be implemented. “In fact, we see the inevitability of launching a new market support tool,” Deutsche Bank said. “We do not believe that the ECB will go far enough in the tightening cycle without a stability tool.” A new program, the German bank adds, would also boost perceptions of how high the terminal rate could be: a new buying tool could tighten the economic conditions needed to curb inflation further. by raising policy rates rather than higher spreads, he explains.

Deutsche Bank’s new interest rate forecasts are up 25 bp in July, 50 bp in September, 50 bp in October and 25 bp in December. The deposit rate will be at 1% by the end of the year. It then expects further interest rate hikes of 25 basis points in the first half of 2023, with interest rates hovering at 2% until June 2023.