A rate hike at Thursday’s ECB meeting is all but certain. What is more exciting is what details the central bank reveals about its aid instrument for the heavily indebted euro countries.
The ECB has waited a long time. But now the first interest rate hike in almost ten years is also pending in the euro zone. The majority of observers expect an increase of 0.25 percentage points after the Council meeting on Thursday. Even 0.5 percentage points are not ruled out in view of the high inflation rates of 8.6 percent in June.
Regardless of how much it will be, the ECB’s monetary policy will remain expansive. After a large rate hike, the key interest rate would be just zero and real interest rates would remain deep in negative territory. The ECB is even a long way from a neutral interest rate level that is neither expansive nor restrictive. Experts put it in the range of two to three percent. And reducing its balance sheet is not even under discussion at the ECB. Although the central bank no longer buys new bonds, maturing bonds are reinvested. So no liquidity is withdrawn from the market.
However, the ECB’s ability to act is limited. On the one hand, a significant intensification would increase the risk of recession in the euro zone. The economic prospects are clouded anyway because of the high energy prices and the uncertainty caused by the Ukraine war. On the other hand, higher interest rates would cause difficulties for the heavily indebted euro countries, led by Italy. Yields rose significantly after the first signs of a turnaround in interest rates. Concerns about a new debt crisis arose.
This leads to the second major topic of the ECB meeting: In order not to let the fear of state bankruptcies arise in the first place, the ECB wants to cap the risk premiums with a new instrument. Officially, the ECB is concerned with preventing a “fragmentation” of the euro area, because otherwise it sees the effectiveness, the “transmission”, of its monetary policy restricted. The central bank understands “fragmentation” to mean that the financing conditions of the euro states differ exaggeratedly. This could be the case, for example, when speculators bet on a euro member state going bankrupt.
But it is clear to virtually every observer that the diminishing effectiveness of monetary policy is only an excuse. The truth is that the highly indebted countries can continue to borrow money cheaply.
Only a few details of this new instrument are known so far. It will be called the “Transmission Protection Mechanism” (TPM) and will be used if the yield spreads exceed the economically justified level. In other words, the ECB would then buy government bonds from the countries as part of this program in order to lower yields.
The problems with the TPM are numerous:
The ECB must give an answer to all these questions that convinces the markets. Expectations for more specifics after Thursday’s meeting are high. It is speculated that the central bank will not commit itself to precise criteria (e.g. the size of the spreads) as to when purchases will be made as part of the TPM, but will reserve the right to make individual decisions. In addition, the ECB is likely to announce that the purchases will be unlimited or specify a significant total purchase volume.
The ECB may hope that it will make its commitment so clear (“Whatever it takes” 2) that the program will never have to be used. In the past, this hope has often turned out to be wishful thinking. As a rule, the markets want to see that central banks are really ready to act. So the ECB should brace itself for one or two challenges.
