The head of Germany’s Bundesbank has warned it will be “virtually impossible” to decide if a divergence of borrowing costs between eurozone countries is justified, arguing it would be “fatal” for governments to rely on the European Central Bank’s support.
Joachim Nagel’s comments in a speech on Monday were the first sign of serious disagreement at the ECB over its plan to develop a new asset purchase tool to counter any “unwarranted” surge in the bond yields of more vulnerable countries once it starts raising interest rates.
Nagel said “it would be fatal if governments were to assume that the eurosystem will ultimately be ready to assure favourable financing terms for the member states”, and that rate-setters could find themselves in “dire straits” legally over the tool.
The comments by Germany’s central bank chief reflect rising concern among more stable northern European countries that the ECB risks overstepping its mark to keep bond yields low for more indebted southern member-states. Some policymakers worry that if governments are not encouraged to rein in spending it could undermine the ECB’s effort to tackle high inflation.
Since the ECB announced plans to start raising rates this month, bond yields of weaker countries like Italy have soared faster than those for more stable countries like Germany, prompting it to accelerate work on a “new anti-fragmentation instrument”.
It is against EU law for the central bank to finance governments and Nagel said the ECB would have to put enough safeguards in place to avoid straying into “monetary financing”.
The central bank has defended its earlier bond-buying against numerous legal challenges in Germany, but this could be harder now without the justification of fighting excessively low inflation.
The ECB worries that a bond market panic could push up weaker countries’ borrowing costs to a level that tips them into a financial crisis. It believes a new tool to counter this risk is justified as it would preserve its ability to transmit monetary policy evenly to all 19 members of the single currency bloc.
The difference, or spread, between German 10-year government borrowing costs and those of Italy has doubled from 1 percentage point a year ago to around 2 percentage points in recent weeks.
Nagel, however, cautioned against “using monetary policy instruments to limit risk premia, as it is virtually impossible to establish for sure whether or not a widened spread is fundamentally justified”.
“One can easily find oneself in dire straits,” he said, adding “it is clear that unusual monetary policy measures to combat fragmentation can be justified only in exceptional circumstances and under narrowly defined conditions”.
Since Nagel took over at the Bundesbank at the start of the year, he has become increasingly concerned as eurozone inflation has shot up to a record level of 8.6 per cent. He said the ECB, of which he is a member of the governing council, should “concentrate all of our efforts on combating this high level of inflation”.
The German central banker set out a number of parameters for any new instrument by the ECB, including that it be “strictly temporary” and be designed in a way that it did not hamper its efforts to bring inflation back down to its target. He added that it should provide governments with “sufficient incentives” to achieve sustainable debt levels.
Such a tool should be “predicated on comprehensive and regular analyses covering a broad set of indicators” and only be used if interest rate spreads are “the result of excesses in financial markets”, he added.