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The ECB Is Back on the Front Line of Crisis 

The ECB Is Back on the Front Line of Crisis 

(Bloomberg) -- More than half a trillion euros of emergency fiscal aid by the European Union apparently isn’t sufficient to shift the burden of fighting the coronavirus crisis from the European Central Bank.

Just over a week since governments reached an uneasy agreement on a joint rescue package, strains in markets are reappearing, underscoring lingering worries that the accord isn’t adequate.

The upshot is that the onus might already be back on the ECB to restrain borrowing costs -- just a month after it unveiled a new 750 billion-euro ($810 billion) bond-buying program.

The ECB Is Back on the Front Line of Crisis 

The key measure haunting policy makers is the widening gap between the bond yields of indebted euro-zone nations worst-hit by the virus, Italy and Spain, and the most fiscally powerful country, Germany. It’s a tale familiar from the region’s recurring sovereign debt turmoils, with the added element of populists -- notably in Germany and the Netherlands -- seeking to make political capital from handouts to those in need.

“Probably the most imminent, the most immediate trigger is what’s happening in the Italian government bond market,” said Nick Kounis, an economist at ABN Amro in Amsterdam who expects the ECB to expand stimulus by another 500 billion euros this month. “Clearly on March 18 the ECB drew a line in the sand, and markets look to be testing that.”

One reason investors might be bold enough to challenge the central bank is that the extra bond issuance governments will need is huge. Estimates run into the hundreds of billions of euros, raising questions over whether it can all be soaked up.

Another is that European finance ministers made their 540 billion-euro support package mostly reliant on loans that will add to national debt burdens.

Fiscally conservative members shunned the idea of joint bonds that could have made it easier for stricken countries to finance their virus response, but would have risked a nationalist backlash at home.

“The absence of significant fiscal burden sharing at the EU level -- with coronabonds off the table for now -- has highlighted the enormity of the ECB’s task,” said Katharina Utermoehl, senior economist at Allianz SE.

Italy, too, has been reluctant to accept funds from the bloc’s bailout fund under attack from euroskeptic opposition leader Matteo Salvini. The nation’s debt is seen by the International Monetary Fund as reaching 155% of gross domestic product this year.

Italian bonds have swung wildly in recent days and there were signs that the ECB had to intervene on Wednesday to halt a damaging sell off. They have rallied since, with the 10-year yield gap over Germany narrowing to 224 basis points Friday, after French President Emmanuel Macron said in an interview with the Financial Times that fiscal transfers from the North to the South would be needed if the EU was to “hold on.”

The rest of Europe’s so-called periphery is also struggling. Spain’s yield spread has widened, and Greece’s second bond sale this year failed to drum up much demand, despite the securities now being eligible for the central bank’s purchase and collateral programs.

Other risk indicators are flashing red, with one measure of the cost of loans between banks rising to the highest in more than four years. The Swiss franc, a traditional haven asset, touched its highest level against the euro since 2015.

“This is a real crunch moment,” said James Athey, a money manager at Aberdeen Standard Investments who is betting Italian 10-year bonds and French securities will decline. “The increases in debt and deficit are too huge for the market to simply accept that the ECB can buy sufficient quantities given the current parameters.”

The ECB Is Back on the Front Line of Crisis 

The extent of the challenge faced by Frankfurt policy makers was laid bare on Tuesday in new IMF forecasts projecting an economic contraction of 7.5% in the euro zone this year. That’s worse than the fund anticipated for major economies such as the U.S.

“European countries are very open to international trade,” Gian Maria Milesi-Ferretti, the IMF’s deputy director of research, told reporters. “Many of them have actually, despite their size, quite a heavy reliance on tourism. Those are all sectors that are hit very heavily.”

ECB President Christine Lagarde should be acutely wise to the dangers, having witnessed the euro zone’s last debt crisis both as French finance minister and then as head of the IMF, just as investors speculated the common currency would splinter. Back then, as now, the ECB has remained the first line of defense while governments prepared a response of their own.

She was in the audience when then-President Mario Draghi declared in his famous speech of 2012 that his institution would do “whatever it takes” to save the currency, eventually stemming the meltdown.

Lagarde inadvertently undermined that pledge last month by saying the ECB’s job isn’t to close the spreads, but she’s now promising to do “everything necessary” to help the bloc through the crisis.

European leaders have a chance to up their own game when they meet again on April 23. One idea circulating in Brussels is an increased EU budget. In the meantime though, the central bank remains on the front line.

“At some point down the line, the ECB is going to be unable to play the role it’s playing right now, and then they will go back to governments,” said Kounis. “But for now, it’s all about the ECB really.”

©2020 Bloomberg L.P.