Earlier today we reported that according to Reuters sources, the ECB was preparing for a Brexit deja vu, and was preparing to "temporarily step up purchases of Italian government bonds if the result of next Sunday's crucial referendum "rocks markets" and sharply drives up borrowing costs for the euro zone's largest debtor."
To be sure, this could be merely a placeholder "trial balloon", leaked by the ECB to its favorite Reuters intermediary, meant to prevent a preemptive selloff of Italian (mostly bank) stocks and/or sovereign bonds, which have come under intense pressure in recent days on concerns that the referendum could lead to another banking crisis. After all, as Brexit so vividly showed, why sell if a central bank has "got your back."
However, a more nuanced read of the article suggests that it may also be bous. Surprisingly, most vocal denial so far today has come from JPMorgan, whose analyst Greg Fuzesi writes in a note titled "ECB: doubting the "sources" story on Italy" that the bank is "highly skeptical of the Reuters story" for four key reasons (listed below), as a result of which JPM says "we find it impossible to imagine the current QE programme being use to intervene in Italy without prior approval from the Governing Council. Finally, even if the ECB were minded to intervene in Italy, bond yields would likely have to rise dramatically from current levels before it acted."
Here is the explanation, and the justification why Reuters "sources" are wrong, according to JPMorgan.
A Reuters story, quoting ECB “sources”, argues that the ECB could use its €80bn/month QE programme to intervene in the Italian bond market should a “no” vote in Sunday’s referendum lead to a “further spike” in Italian bond yields. According to the “sources”, such a reallocation of QE purchases from bonds of other countries to Italian bonds could last for days/weeks and might not require Governing Council approval as it could be done within the existing flexibilities of the QE programme. The story recognizes that longer-term support would require a formal request for help by the Italian government (presumably to the ESM).
From a legal perspective, the ECJ ruling on OMT has given the ECB a lot of freedom to design and use policies it considers to be effective and proportionate. It is also true that the capital key is applied with some flexibility in the current QE programme. And, during last year’s Greek crisis, we argued that the ECB could launch an “Anti- Contagion Programme”, which did target interventions in bond markets that suffered from spillovers from Greece and without requiring OMT-style conditionality. See here.
Despite this freedom, we are highly skeptical of the Reuters story.
- First, the current QE programme is designed to achieve the inflation target and it would therefore be better from a legal and policy perspective to do any country-specific interventions through a new programme (or more appropriately through the existing OMT).
- Second, it is hard to see the ECB intervening in Italy without any conditionality, given that Italy is mostly suffering from home-grown problems rather than an external shock; hence our Anti-Contagion Programme idea is not relevant to the Italian case.
- Third, the flexibility in the current QE programme deals with the case where the intended bonds cannot be bought in a country due to scarcity; reallocating purchases to Italy when bonds can still be bought elsewhere would alter the nature of the existing flexibility.
- Fourth, for all these reasons, we find it impossible to imagine the current QE programme being use to intervene in Italy without prior approval from the Governing Council. Finally, even if the ECB were minded to intervene in Italy, bond yields would likely have to rise dramatically from current levels before it acted.
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Cogent arguments aside, should the Italian (and European) market indeed "turmoil" on a "NO" vote as polls widely expect, there is zero doubt that the ECB will do precisely as it has warned, and intervene massively to prevent yet another price discovery. After all, as was noted on Twitter earlier this morning...
Relax Mario, nobody thought the market would be allowed to operate on its own https://t.co/ehOTxw6RZf— GreekFire23 (@GreekFire23) November 29, 2016