Rocking the Boat
- We take another look at Italy which came under market pressure last week. Beyond the developments in Rome, the discussions at the ECB on banks’ reserve requirements and PEPP are not helping.
- Unexpected 6-week respite on the US government shutdown came at the expense of support to Ukraine.
The “Table Mountain” approach to monetary policy may not bring the expected sense of “peace and quiet.” The bond market has been very active across the Atlantic and, as usual, the weaker signatures get under pressure. Even if we should not overstate the magnitude of the turmoil last week, Italian long-term yields approaching a 200-bps spread vis-à-vis Bunds deserves some attention.
As often, pressure on the Italian bond market was triggered by the combination of some national policy moves (an upward revision in the deficit trajectory) and deteriorating cyclical indicators. A third ingredient is the noise coming from the ECB on a swifter action on its balance sheet. We thought Christine Lagarde had put this to rest when she stated at the last post-meeting press conference that terminating the reinvestment of PEPP had not even been discussed at the Governing Council. Yet, more avenues are being opened, e.g., the possibility to significantly raise the Minimum Reserve Requirement of banks to force a transfer from excess reserves to non-interest-bearing mandatory ones. While this may read as an obscure technical move, the distributional consequences could be significant, triggering an asymmetric additional tightening in monetary conditions detrimental to peripheral countries. The financial stability and macro consequences of such action, combined with good news last week on the European inflation front, should convince the ECB to move cautiously, but we do not think national governments have taken the full measure of the changes at work at the central bank. It may be slow, but the ECB’s balance sheet is only heading in one direction, and fiscal policy needs to adjust to this new reality.
Meanwhile, in the US a last-minute stopgap has given us a 6-week respite in the shutdown drama, but additional funding to Ukraine was a collateral victim. It is tempting to connect this to the electoral victory of Robert Fico in Slovakia to find that more cracks are appearing in the consensus in the West to stand with Kyiv.