(Bloomberg) -- European Central Bank Vice President Vitor Constancio said policy makers are watching Italian bond spreads that widened as populist parties inched closer to forming a government with promises of tax cuts and increased spending for the country with the continent’s biggest public debt.
“There is this spike, we have to see how it will develop,” Constancio, whose eight-year term ends this month, said in a Bloomberg Television interview. “We have to monitor that situation of course, it’s a change from what has been happening recently.”
Italian bonds slid this week and the yield gap with German debt widened in anticipation of an agreement between Five Star and League parties, stirring memories of past episodes of market turbulence that prompted the ECB to step in. The central bank is moving cautiously as it tries to gauge when to end years of extraordinary stimulus.
After 10 days of negotiations, leaders sealed a coalition agreement on Friday that aims to ramp up spending on the poor and slash taxes in a direct challenge to the European Union establishment. Five Star leader Luigi Di Maio said the policy platform is ready for party members to vote on. A nomination for prime minister has yet to be made.
Constancio said the problems of Italy are “known by everyone, particularly in the market” and a lot will depend on the policies eventually implemented.
The euro exchange rate, on the other hand, is no longer the worry it was a few months ago, he suggested. Asked if he was comfortable with the current level, he said “yes.” Policy makers fretted about currency volatility earlier this year, saying they’ll monitor the impact on inflation as they struggle to reach their goal of just under 2 percent.
“We have seen different movements now in the dollar,” Constancio said. “We don’t have a target for the exchange rate as you know, and the volatility in foreign-exchange markets, particularly among the advanced economies, has been attributable more to what has happened to the dollar than events linked with other parts of the world.”
He played down a slowdown in the region’s economy, saying it’s in line with ECB projections. Finland’s Deputy Governor Olli Rehn appeared to take a dimmer view on Thursday when he said that “in the short term the risks are relatively balanced, but in the medium term they tend toward the downside.”
Rehn will succeed Governor Erkki Liikanen in July and join the ECB’s decision-making Governing Council. The government announced his appointment on Friday.
Austrian central-bank head Ewald Nowotny, said later that the ECB “shouldn’t wait too long with normalizing monetary policy.”
Earlier on Thursday Constancio used his farewell speech in Frankfurt to call for a bold series of reforms to ensure the euro zone is better equipped to face the next crisis.
Addressing participants of a colloquium marking the end of his term this month, the Portuguese urged euro-area officials to take “the quantum leap” to create a capital-markets union and improve fiscal rules to prevent budgetary excesses of member states. He also called on leaders to create a fiscal-stabilization fund to help the region ride out times of stress, echoing comments by President Mario Draghi from last week.
“The European Monetary Union was a hubristic endeavor from the start, full of unprecedented ambition in historical terms,” Constancio said. “The initial minimalist design didn’t do justice to the wide-ranging implications of the project. The framework is not yet complete and is still risking existential threats.”
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