Bundesbank chief warns against ‘fatal’ assumptions in ECB anti-crisis tool

The head of Germany’s Bundesbank warned that it would be “nearly impossible” to decide whether a divergence in borrowing costs between eurozone countries is justified, arguing that it would be “fatal” for governments to rely on European Central Bank support.

Joachim Nagel’s comments speech Monday was the first sign of serious disagreement at the ECB over its plan to develop a new asset-buying tool to counter any “unwarranted” rise in more vulnerable countries’ bond yields after it starts raising interest rates.

Nagel said it “would be fatal if governments were to assume that the Eurosystem would eventually be prepared to secure favorable funding conditions for member states” and that rate-setters could be in a legal “hard spot” because of this. tool.

The German central bank chief’s comments reflect growing concern among the more stable Nordic countries that the ECB risks overstepping the mark by keeping bond yields low for heavily indebted southern member states. Some politicians fear that if governments are not encouraged to cut spending, it could undermine the ECB’s efforts to combat high inflation.

Since the ECB announced plans to start raising rates this month, bond yields in weaker countries like Italy have risen faster than those in more stable countries like Germany, prompting it to speed up work about the “new anti-fragmentation tool”.

EU law prohibits the central bank from funding governments, and Nagel said the ECB would have to take sufficient precautions not to fall into “monetary financing.”

The central bank protected its previous bond purchase from numerous legal problems in Germanybut it could be more difficult now without the justification of fighting excessively low inflation.

The ECB fears that a panic in the bond market could raise the cost of borrowing for weaker countries to levels that could lead them into a financial crisis. it believes a new tool to counteract this risk is justified, as it would retain the ability to evenly transmit monetary policy to all 19 members of the single currency bloc.

The difference, or spread, between German and Italian 10-year government borrowing costs has doubled from 1 percentage point a year ago to about 2 percentage points in recent weeks.

Nagel, however, cautioned against “using monetary policy instruments to limit risk premiums, since it is almost impossible to establish with certainty whether a wider spread is fundamentally justified.”

“It can be easy to find yourself in a desperate situation,” he said, adding that “it is clear that unusual monetary policy measures to combat fragmentation can only be justified in exceptional circumstances and under narrowly defined conditions.”

Since Nagel took over at the Bundesbank earlier in the year, he became increasingly concerned that inflation in the euro area had jumped to record level or 8.6%. He said the ECB, of which he is a member of its governing board, should “focus all our efforts on combating this high level of inflation.”

The head of the German central bank has set a number of parameters for any new ECB instrument, including that it must be “strictly temporary” and designed in a way that does not hinder its efforts to bring inflation down to its target. He added that this should provide governments with “sufficient incentives” to achieve debt sustainability.

He added that such a tool should be “based on comprehensive and regular analysis covering a wide range of indicators” and used only if interest rate spreads are “the result of excesses in financial markets.”