The writer is chief economist at the German bank LBBW
With the rise in inflation in the eurozone, the pressure is necessarily based on the European Central Bank stepping up its planned monetary policy.
In March, European Central Bank President Christine Legard Explained How was the late normalization of monetary policy in Frankfurt observed: In the third quarter, bond purchases could be reduced to a net zero, with only maturing securities being replaced. Only then will interest rates be raised “gradually”.
The ECB is likely to be concerned that a faster normalization of monetary policy, compared to the moves of the Federal Reserve or the Bank of England, could pose risks to the stability of financial markets. For this reason, he may prefer to move only carefully, almost as if on eggshells.
What is the problem? A major concern seems to be Italy. Will the state be at risk of falling into debt abyss if the super-loose interest rate rises?
The ECB may feel disqualified once. As early as March 2020, Lagard stated at one of her first press conferences that the ECB was not there to close government bond margins. This is not wrong, of course. But her words have not yet faded when A. Great sale Of Italian government bonds have begun, worse than on any single day of the euro crisis. Lagard had to row everything back right away.
But the ECB should leave the difficulties of that day behind. It should not face a more courageous tightening of financial conditions than it has hitherto delivered. The fear that Italy’s high debt burden could pose a challenge to monetary normalization cannot be dismissed out of hand. But Italy’s resilience has become much more solid than many lawmakers give it credit for.
Laguard’s announcement last month that the ECB would complete its huge bond purchases earlier than expected provoked a relatively restrained response in Italian government bonds.
To be sure, it will not be without consequences if the ECB stops buying the equivalent of all new issuances of euro government bonds, as it has been in the last two years. Interest rates have already risen. Spreads are expected to widen even further.
Italy is in a better position than many viewers believe: high inflation reduces government debt. With nominal inflation-driven growth of 10%, Italy’s debt ratio falls by 15% of GDP in 2022, the rest. It helps.
It helps even more that the effective interest rate is very low. Italy pays average interest on its debt, which has fallen to just 2%, right on the ECB’s inflation target and well below inflation. Higher yield bonds issued a decade ago are still mature and can be recycled cheaper today. The effective interest burden will therefore remain low or even fall for a few more years.
Something else is both extraordinary and positive. Italy now has a stable and competent government that enjoys broad parliamentary support. This is by no means self-evident in a country where the last “elected” prime minister, namely the candidate at the top of the winning party list, was one Silvio Berlusconi, almost fifteen years ago.
Finally, Italy will have to issue less debt than many realize. The average life expectancy of Italy’s public debt is seven years, even if the Treasury did not take advantage of the super low rates to extend its repayment profile. Only a small portion needs refinancing each year. And Rome pre-financed in the first quarter while the ECB’s 1.85 TLn Euro “asset purchase program” was still in place.
Rome’s borrowing needs will be further reduced through significant budgetary relief from the European Union’s next-generation rehabilitation fund. Between 2023 and 2025, Italy Can expect Annual grants of more than one percent of its gross domestic product and again a little more than that through cheap EU loans.
This makes the likelihood of a prime minister much more Mario Draghi He would be able to push structural reforms to address Italy’s growth weakness than any of his predecessors, including Mario Monti, who was forced to run strict public finances.
The risk of inflation spiraling out of control is rising rapidly. The ECB must shift gears. The fear that Italy will not be able to cope economically is unfounded. It can and it will. All the stars are aligned, and it will not get any better than that. The longer it takes to scrape, the more likely it is that an Italian government crisis will get in the way. So it will be really complicated to raise rates. Do not wait!
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