Her Eleftherias Kourtali
Morgan Stanley estimates that the most likely scenario is for the ECB to announce today more details about PEPP’s reinvestment program and emphasize their flexibility by starting the Italian and Greek bond markets, rather than a new tool. However, it is not certain that this will be enough to finally address the risk of fragmentation.
According to Morgan Stanley, the transmission of monetary policy is based on the impact that interest rate hikes will have on borrowing costs in the euro area economy. When the ECB raises interest rates, borrowing costs should increase linearly in all euro area countries. If this is not the case, that is to say, the cost of borrowing increases significantly more in some countries than in others, the ECB is faced with a fragmented transmission situation.
The President and other ECB policy makers have stated that they will not tolerate a fragmented transmission of the ECB’s monetary policy and that they have all the tools at their disposal to deal with such a situation. In particular, the ECB has emphasized the possibility of flexibly using reinvestments under PEPP. In addition, there have been repeated reports of a new anti-fragmentation tool.
Morgan Stanley sees three possible outcomes:
Verbal intervention: The ECB could simply decide to issue a statement, similar in content to yesterday’s speech by Governing Body member Isabel Snabel.
PEPP reinvestments: The ECB could formally decide to activate PEPP reinvestment flexibility and start buying Italian and Greek bonds. It can also announce a special folder.
New anti-hash tool: The ECB could decide on a new program and announce its key features today. The program will probably start only a few days after the announcement.
“We believe that the second scenario is the most likely. Only verbal intervention seems to be insufficient at this stage. At the same time, the time to introduce a new program has probably not come, as the expansion of spreads observed so far has not been systemic. In addition, PEPP reinvestments have been reported many times, but so far have not been actively used, and it seems likely that the ECB will first exhaust this tool before launching a completely new program to control regional spreads, “said Morgan Stanley.
In any case, according to the US bank, even the full distribution of PEPP reinvestments in the peripheral countries would represent only one third of the total gross supply. Thus, while announcing PEPP reinvestment may be enough for today, it is unlikely to be fully adequate to address the risks of fragmentation.
Source: Capital
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