"ECB Embarks on Risky Course"
Fresh Take:
The European Central Bank (ECB) recently made a historic decision to raise interest rates by 0.5 percentage points, signaling a significant shift in monetary policy after eleven years. Clemens Fuest, head of the Ifo Institute, applauds the move, but warns about potential risks for highly indebted countries like Italy.
BÖRSE ONLINE: How precarious could the situation get for highly indebted EU nations such as Italy due to the ECB's strong interest rate increase?
Clemens Fuest: The full impact of the higher interest rates on Italy's public finances will take some time to manifest, as the average maturity of outstanding Italian government bonds is seven years. However, escalating inflation simultaneously boosts tax revenues and reduces the real value of public debt.
Bond Time Bomb?
Despite concerns about a potential time bomb related to the rising interest rates, it's essential to consider the long-term growth prospects of Italy and the confidence of investors in the Italian government. If that trust is absent, it could pose problems.
ECB's Bond-Buying Program:
Clemens Fuest criticizes the ECB's crisis bond-buying program, known as the Transmission Protection Instrument (TPI), stating that the ECB might be encroaching on state financing, risking its independence, and fostering incorrect incentives for financial and economic policy.
Eligibility for TPI and OMT Comparisons:
While the ECB stresses that TPI participation depends on a solid and sustainable fiscal policy in the respective country, Christine Lagarde's assurances are weaker than those of the bond-buying program OMT introduced during the euro crisis. Unlike the OMT, the ECB could come under immense pressure to support individual member states without specific bindings.
Interest Rate Hike Evaluation:
Clemens Fuest sees the ECB's interest rate hike as a necessary step, signaling the bank's resolve to continue normalizing monetary policy, away from bond purchases and negative interest rates. However, it is still too early to rule out the possibility of future negative interest rates in low-inflation situations.
Timing and Effectiveness of the ECB's Actions:
While the interest rate hike may be somewhat late given the surging inflation rates, Fuest emphasizes that it's better late than never. The exit from bond purchases and interest rate hikes mark the start of the ECB's attempts to combat inflation but do not mark the end of the road, as the Bank still has a long way to go to bring rates to a neutral level.
- Clemens Fuest suggests that, while the escalating inflation in Italy might temporarily boost tax revenues and reduce the real value of public debt, the full impact of the higher interest rates on Italy's public finances remains to be seen, due to the average maturity of outstanding Italian government bonds being seven years.
- In the context of the ECB's bond-buying program, Clemens Fuest expresses concerns about the Transmission Protection Instrument (TPI), arguing that the ECB might be encroaching on state financing, risking its independence, and fostering incorrect incentives for financial and economic policy.
