The ECB’s northern hawks are spoiling for a fight. Austria’s governor Robert Holzmann is calling for three rate rises this year. It is the same refrain from Finland and the Netherlands.
Isabel Schnabel, Germany’s member on the executive council and a political bellwether, has suddenly switched sides. “We need to prevent high inflation from becoming entrenched in expectations. Talking is no longer enough, we need to act,” she told Handelsblatt in a fire-breathing interview last week.
She talked of ending all QE asset purchases by late June, and suggested a rate rise – from minus 0.5pc – as soon as July. The warning to markets could not be clearer.
The ECB thinks it can continue to protect Italy come what may, chiefly by switching ever more of its existing portfolio into Italian debt as old bonds expire.
But this implies accumulating most of Italy’s national debt over time. It runs into serious technical, legal, and political limits. Fabio Balboni from HSBC said the markets are likely to “test” this defence.
The ECB staff have been working on a further anti-spread weapon for months, but this has yet to see the light of day, probably because it violates the Lisbon Treaty’s no-bail clause. The scheme will face an inevitable challenge at the German constitutional court.
If all else fails, there is a final “nuclear option” to back-stop Italy’s debt. It was designed by Mr Draghi himself when he ran the ECB a decade ago.
It is composed of loans from the EU bail-out fund (ESM), which can then trigger targeted bond purchases by the ECB as a supporting measure. But the rescue package requires the approval of the German Bundestag and other parliaments. The conditions would be draconian.
The instrument has yet to be ratified in Rome because of resistance from the political right. A Fratelli-Lega coalition would be loath to activate the process until Italy was on the brink of default. By then the contagion spreading through Spain, Portugal, and the rest of Club Med would risk a replay of the debt crisis in 2011.
In a sense, Italy has been in suspended political animation since 2018, when voters elected anti-euro parties of left and right in a primordial scream against the status quo.
The establishment poteri forti found ways to finesse this over time, ultimately installing a technocrat government more to their liking under the quintessential Mr Euro, with no elections along the way to legitimise this 180-degree reversal. They have not yet found a way to abolish voting altogether.
Italian political risk is back on the table, just as the ECB debt shield disappears.
