by Luca Ruggeri
The Governing Council of the European Central Bank on July 21 made two important monetary policy decisions; first, an interest rate increase of 0.50 percent to combat inflation, and also the introduction of a new monetary instrument.
What TPI is
In detail, about this second regard: the ECB created the Transmission Protection Instrument (TPI) aimed at preventing fragmentation of the euro area. In short, it is an instrument designed to protect financially weaker countries, all the more relevant after the ECB ceased purchases related to the pandemic crisis situation that had essentially "anesthetized" the spread.
The new TPI does not have a maximum amount - which is undoubtedly a very positive aspect - but it does stipulate that a country wishing to use it will have to comply with several conditions. In detail:
- will have to comply with EU parameters and thus not be subject to an excessive deficit procedure (EDP) and will also have to comply with the Commission's recommendations;
- should not be subject to a macroeconomic imbalance procedure;
- will have to be in a fiscally sustainable situation;
- will have to implement sustainable policies thus following European fiscal recommendations and Recovery Plan commitments (the latter provision seems to look specifically at Italy given the significant commitment planned for the national RRP).
How it has been received
A new instrument, robust in amounts and agile in use, was widely expected by the market, and the ECB had to come up with an initiative on it, because failure to do so would have triggered a crisis for financially weaker countries including Italy.
The TPI has been met with comments of varying emphasis: some have pointed out that its very existence is a guarantee even if with political costs should it be activated; others point out that, in fact, the use of the TPI implies a commissioning of the country that requires its intervention.
Markets, the true judges of the TPI, have not appeared particularly enthusiastic about the new instrument prepared by the ECB.
The now infamous BTP/Bund spread has not decreased, but credit default swaps (a contract used to hedge against the risk of default by a borrower) have not moved either. In detail, the cost difference between credit default swaps with 2003 contractuals (which do not include currency change as a cause of default) and those with 2014 contractuals (which do), a spread considered an index of the risk of "Italexit," has not shown significant movement since the announcement of the TPI, proving that the TPI itself is not seen as a real solution to the problem of the financial crisis of one of the European countries.
Illustrative is an article that appeared on July 22 in "IlSole24Ore," where the comments of twenty investment houses were summarized, which, beyond the opacity of the TPI, pointed out that the four conditions listed above are far more numerous than what traders anticipate. Another problematic aspect identified in the article is the difficulty of understanding when there is an unwarranted, disorderly market situation ("unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area") that empowers the ECB to activate the TPI and, consequently, at what level of spread such activation will occur.
A weak tool
In a nutshell, what the TPI seems to lack is the ability to convince markets of the existence of an instrument that can be easily deployed to support a country, in contrast to the OMT (Outright Monetary Transactions) program prepared by Draghi at the time -which, moreover, has never been used - and which involves the use of the ESM (European Stability Mechanism), which is still operational to this day.
All that remains is to hope for careful handling of the economy by the new government, expression of the September 25 vote, as the protection offered by the ECB is likely to be tested by the markets in the event of economic disruptions, with outcomes difficult to predict.
Senior Fellow at the Centro Studi Machiavelli. A graduate in Economics, he worked for over twenty years at a large Italian bank and currently serves as a general manager at an institutional investor.