What could spur the ECB into action in Italy?


  • Banking
  • Friday, 01 Jun 2018

FRANKFURT: Italy is engulfed in political and financial turmoil of a kind not seen since the eurozone’s debt crisis at the start of the decade.

The country has searched for a government since inconclusive elections, with two anti-establishment parties the latest to fail to form a ruling coalition, after the president demanded a change in their cabinet lineup.

With repeat elections likely to lead to a eurosceptic government in Rome, long-dormant speculation about an Italian exit from the euro has resurfaced.

The European Central Bank (ECB) does not see a need to react for now, however, because key financial indicators have yet to show signs of acute stress.

Here are some examples of the indicators ECB president Mario Draghi and his colleagues are likely to be monitoring:

> Bond spread: This spread measures the premium investors demand for holding debt issued by Italy over that of top-rated Germany.

It is considered a gauge of investor nerves about Italy’s debt situation.

While this spread has widened markedly in recent weeks, it’s still at roughly half the record levels hit in 2012, before Draghi pledged to do ”whatever it takes” to save the euro.

> Bets on quitaly: Economists, including at the ECB, have used the price of credit default swaps on government debt in euros and dollars to gauge whether investors were betting on a country leaving the eurozone.

For Italy, this gauge of redenomination risk is even higher now than it was at the height of the debt crisis.

The rate at which banks are prepared to lend to each other is a measure of their mutual confidence.

In Italy’s case, it is not showing any change and Italian banks, like their peers in large eurozone countries, are still paying a negative interest rate – that is, they are actually getting paid – to borrow against collateral. This is the result of the ECB keeping its own deposit rate below zero, effectively charging banks for their idle cash to spur them to lend.

Unlike during the financial crisis, however, banks are now mostly lending to one another against collateral via repurchase agreements, or repos.

Repos are a safer form of credit because the lender gets to keep the collateral – in Europe, typically a high-rated government bond such as Germany’s – if the borrower can’t pay back.

If banks run out of the best collateral, they can always turn to the ECB, the euro one’s central bank.

So far, however, they haven’t. This is probably due to the two trillion euros (US$2.33 trillion) of cash the ECB has already pumped into the system over the past three years via its bond-buying stimulus programme.

Banks, particularly in richer countries like Germany and France, are replete with money and even happy to pay a small price to lend it out and avoid depositing it at the ECB overnight at a penalty rate. — Reuters

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