Ah, here we go again. Just when you think that the bond market is finally starting to hold governments accountable for their fiscal decisions, along comes the ECB with a reminder to everyone that it has tools to come to the rescue. How convenient.
ECB president Lagarde remarked yesterday that the central bank has the necessary tools to counter “unwarranted” market dynamics, in what surely is a reference to the ongoing turmoil in European bond markets.
Now, I don’t have a problem with the ECB stepping in when markets genuinely become dysfunctional. However, there is one thing that really bothers me about her statement. What exactly constitutes to an “unwarranted” market move in this particular case?
Well, it is not difficult to draw a connection with what is happening in France right now. The country is running a budget deficit of more than 5% of GDP and public debt is approaching 120% of GDP. Meanwhile, a political gridlock is stopping any meaningful fiscal reform from taking place.
So if investors are demanding higher yields in order to compensate for those risks, isn’t that just the bond market doing its job? Pfft. I mean, at what point does a reasonable repricing of fiscal risk suddenly become something that warrants central bank intervention? Where does one actually draw the line on that? And better yet, who exactly gets to decide where that line should be drawn?
The ECB’s Transmission Protection Instrument (TPI) is designed to address disorderly market conditions that threaten monetary policy transmission. It is not meant to provide governments with a convenient escape route from their own fiscal problems.
As such, France’s ongoing excessive deficit procedure raises questions over whether it would even qualify for intervention under the ECB’s existing framework. And I would argue that is exactly the reason why Lagarde’s choice of words deserves scrutiny here.
The ECB should be staying in their lane and focus on the mandate of delivering on price stability, not to shield governments from the consequences of poor fiscal choices. If intervention starts to border on the lines of being a backdoor bailout, then the distinction between monetary policy and fiscal support becomes rather blurred. And that is quite a dangerous precedence to set.
Just think about it. If politicians know that the ECB will eventually ride to the rescue whenever borrowing costs become too painful, then where is the incentive to make those difficult fiscal decisions in the first place?
Let’s be real. The bond market isn’t necessarily broken just because governments don’t like what investors are telling them.
This article was written by Justin Low at investinglive.com.