The head of Germany’s Bundesbank has warned that it will be “virtually impossible” to decide whether a divergence in borrowing costs between eurozone countries is justified, arguing that it would be “deadly” for governments to rely on support from the European Central Bank.
Joachim Nagel’s comments in a speech on Monday were the first sign of serious disagreement within the ECB over its plan to develop a new asset-buying tool to counter any “unwarranted” rise in bond yields on most vulnerable countries once it begins to raise interest rates.
Nagel said that “it would be fatal for governments to assume that the eurosystem will finally be ready to provide favorable financing conditions to member states”, and that rate officials could find themselves legally “in dire straits” about of the tool.
The comments from the head of the German central bank reflect growing concern among more stable northern European countries that the ECB risks overstepping its mark to keep bond yields low for the most indebted southern member states. Some policymakers worry that if governments aren’t encouraged to rein in spending, it could undermine the ECB’s efforts to tackle high inflation.
Since the ECB announced its intention to start raising rates this month, bond yields in weaker countries like Italy have climbed faster than those in more stable countries like Germany, which urged to speed up work on a “new anti-fragmentation instrument”.
It is against EU law for the central bank to finance governments and Nagel said the ECB should put enough safeguards in place to avoid getting lost in “monetary financing”.
The central bank has defended its earlier bond purchases against numerous legal challenges in Germany, but it could be more difficult now without the rationale of tackling excessively low inflation.
The ECB fears that a panic in the bond market could push the borrowing costs of weaker countries to a level that would tip them into a financial crisis. It believes that a new tool to counter this risk is warranted as it would preserve its ability to transmit monetary policy equally to the 19 members of the single currency bloc.
The difference, or spread, between German government 10-year borrowing costs and Italy’s 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 with certainty whether a widened spread is fundamentally justified or not.”
“One can easily find oneself in a desperate situation,” he said, adding “it is clear that unusual monetary policy measures to combat fragmentation can only be justified in exceptional circumstances and under tightly defined”.
Since Nagel took office at the Bundesbank earlier this year, he has become increasingly worried as eurozone inflation has soared to a record high of 8.6%. He said the ECB, of which he is a member of the board of governors, should “focus all our efforts on tackling this high level of inflation”.
Germany’s central banker has set out a number of parameters for any new ECB instruments, including that it be “strictly temporary” and designed in such a way as not to hamper its efforts to bring inflation back to its target. He added that it should provide governments with “sufficient incentives” to reach sustainable debt levels.
Such a tool should be “based on comprehensive and regular analyzes covering a wide range of indicators” and only be used if interest rate differentials are “the result of excesses in the financial markets”, a- he added.