Tensions between Italy and the European Central Bank are increasing. While the institution has been active for more than six months to curb inflation, Rome is reluctant to see the new strategy. Giorgia Meloni’s government accuses the ECB of “worsening” the country’s economic situation.
“It doesn’t take a Nobel Prize, you just need the common sense of a housewife to understand that certain decisions have negative repercussions because they aggravate the crisis,” Defense Minister Guido Crosetto told the daily La Repubblica on April 4, describing “the sudden change in the central bank policies (which) could have a particularly negative impact on us.
The ECB’s decision to tighten its monetary policy is being questioned. It has hiked interest rates four times since July, first by 50 basis points, then twice by 75 points, and then by 50 points again. In addition, the ECB has announced the end of its public debt buyback program launched in 2015, which intends to buy back public debt on a massive scale in the secondary market, where economic entities can buy and sell existing financial assets. In other words, the ECB repurchased government debt to lower its funding costs and thereby boost its economy.
She wasn’t the only one to launch such programs, as did the US Federal Reserve, which also put an end to them. In fact, if until then the aim was to fight deflation so that it stabilized at 2%, the price increase curve has now well exceeded this threshold in the euro area, as in the United States or elsewhere. Central banks were therefore forced to reverse policy, this time to fight inflation. This reached 9.2% over a year in the euro zone in December.
“In a way, it was the ECB that funded the sovereign debt of eurozone governments. However, this is not part of their mandate, which is to keep inflation around 2%. Given the current context, the institution believes that by buying public debt, it is encouraging governments to increase their public deficits to allow households to spend more, fueling inflation. By halting its buyback program, it intends to push governments to implement structural reforms to reduce public spending and thereby curb inflation,” summarizes Sandrine Levasseur, economist at France’s Observatory of Economic Conditions (OFCE)-Sciences Po.
Going into debt will cost states more
However, this new strategy is having a particular impact on Italy, the most indebted country in the euro zone after Greece. Its national debt accounts for 150% of its gross domestic product (GDP). In comparison, France achieves 113% of the country’s GDP and about 70% for Germany. Raising interest rates may be an “understandable decision, but not intervening in sovereign debt problems as before is a bit more difficult to understand and justify,” argued Guido Crosetto. “Just look at the finance law” for 2023, he said, noting that “more than 20 billion euros more than last year will be needed to pay the interest on the national debt”.
The end of the ECB’s sovereign debt buyback program means “rates will rise for any country that wants to borrow more,” concludes Sandrine Levasseur. And with good reason, they will no longer be able to borrow from the institution but from the more “challenging” financial markets.
In fact, the ECB’s announcement last June of the end of the buyback program had led to a sharp rise in the interest rate for 10-year Italian bonds. The latter had risen above 4% for the first time since 2014 before falling. Too high a threshold, however, would severely penalize Rome for borrowing in the markets, with the latter raising concerns about its ability to repay the amounts borrowed. “From a growth or even productivity perspective, the markets have the impression that, for example, the German economy is doing better than the Italian one. They therefore forgive the former more easily and at lower interest rates,” the economist concludes.
ECB rate hike: Italy, the Eurozone’s nightmare
This unexpected increase had particularly widened the gap between Italy’s 10-year interest rate and that of Germany, which serves as a reference as it is the country that absorbs the lowest interest rates in the euro zone. Nicknamed the spread, this difference had reached 200 basis points. If that’s far from the 600 points recorded during the eurozone crisis in 2011, it was enough to stoke fears of fragmentation in Europe’s economies.
A new support tool with conditions
To allay Italian concerns, European Central Bank President Christine Lagarde then promised an anti-fragmentation tool. Dubbed the Transmission Protection Instrument (TPI), the instrument was approved on July 21 and “will ensure that the direction of monetary policy is transmitted smoothly across all eurozone countries,” the ECB says. “It can be activated to counteract unwarranted and disorderly market dynamics that seriously threaten the transmission of monetary policy in the eurozone,” the institution adds.
More specifically, “on the secondary market, the Eurosystem may buy securities issued in countries where financing conditions are deteriorating that are not justified by country-specific fundamentals”. It also specifies that “the size of TPI purchases will depend on the severity of the risks of monetary policy transmission”..
However, this is not the only criterion specified by the ECB. It states that “the Governing Council will examine a cumulative list of criteria to assess whether the countries where the Eurosystem can make purchases under the TPI are pursuing sound and sustainable fiscal and macroeconomic policies”.
But “the ECB rightly believes that Italy is not making enough efforts to reduce its public debt,” emphasizes Sandrine Levasseur. For its part, the Italian government has criticized the institution for its speech, which targets Italy without naming it, arguing that it “stokes the fire and thus encourages the interest rate hike demanded by the markets,” she adds. The President of Italy’s Council of Ministers, Giorgia Meloni, while affirming that she would “respect” the autonomy of the ECB, took the view that “in the situation in which we find ourselves, it would be better to avoid taking decisions” that affect the situation aggravate . “It would be useful to manage communications well, otherwise we risk not creating panic but creating fluctuations in the markets that affect the daily work of governments,” she warned.
For or against: Should we resume budgetary discipline and cut government spending? (Jean-Marc Daniel vs. Thibault Laurentjoye)
So should we expect the ECB to refuse to help Italy if it risks bankruptcy? An unlikely scenario, according to the OFCE economist. “The risk is that a spike in lending rates will prevent the country from meeting some of its maturities and it will go bankrupt. But this scenario would shake up the eurozone enormously, as it could result in the exclusion of Italy, one of its founding countries. We would then question the viability of the economic zone. No state, not even the supposedly toughest, has an interest in such a dissolution,” she analyses.
However, the aid would not come without compensation, she warns, explaining: “Once there is solidarity in the EU, it is clear that the institution will have certain demands and Giorgia Meloni does not want to find herself under the supervision of Giorgia Meloni of the ECB, by imposing budgetary austerity measures on it”. Which suggests a real showdown between the institution and Rome.