13 Jun 2018 3 min read

The ECB’s Italian Job


“We trust that the government will take all the appropriate actions” – Jean-Claude Trichet. Mario Draghi. That was the sign-off for the now infamous ECB letter sent to Silvio Berlusconi’s government during the height of the European sovereign debt crisis. Nearly seven years on, Italy has once again experienced financial market turmoil and the ECB this week will no doubt be asked many questions about the situation.


A few weeks ago, most economists were expecting a ‘business as usual’ meeting from the European Central Bank (ECB) in June, with the only excitement provided by a possible announcement or hint regarding the tapering of its asset purchases later this year.

But after the political saga in Italy spilled over into financial markets in May, triggering flashbacks to the dark days of the sovereign debt crisis, investors are asking whether the central bank can end its quantitative easing (QE) programme as is thought to be planned.

The level of support that the monetary guardian could provide to troubled euro members is once again in focus

What’s more, the level of support that the monetary guardian could provide to troubled euro members – not least, a boot-shaped one which happens to be its third largest economy – is once again in focus.

The ECB has remained impressively quiet on the subject since Italy’s populist coalition began forming its government and announcing policy plans (maybe not wanting to wade in this time...). The ruling League and 5-Star parties have shown ambivalence towards the euro and have drawn up lavish spending plans, which investors fret will jeopardise the Italy’s fragile finances.

Over the years, the Italian-born Mario Draghi has been asked many times about the politics of his home country – and the ECB president has always refused to comment on any specifics of Italy. He prefers instead to restate the central bank’s rules and expectations for all countries in the monetary union.

Faced with a crisis that remains very much live in a country whose economy and sovereign debt markets are too big to fail, too big to bail, this time, Draghi may not be able to dodge such questions.

If pressed – and journalists are a persistent bunch – he is likely to reiterate that the ECB’s policies are “flexible”. Indeed, we believe that the restriction on QE to the so-called capital key, a guideline that dictates purchases corresponding to the size of a country’s economy and population, is a rule that can be bent.

Even though investor angst over the country appears to have calmed of late, Italian bond yields remain elevated

Could Draghi even repeat his famous pledge that the ECB will do “whatever it takes” to keep the euro area together (a pledge which, by the way, came within months of that letter)? To that end, the crisis-era outright monetary transactions programme (the policy that allows the ECB to buy the debt of member states whose bond markets are under threat), remains an option. However, market stress would probably need to escalate from current levels, and Italy would be required to accept strict conditions, for this programme to be activated. Even though investor angst over the country appears to have calmed of late, Italian bond yields remain elevated.

As a result, a number of the ECB’s governing council members may err on the side of caution when it comes to announcing the end of its asset purchases, under which they have hoovered up about 16% of the country’s entire government debt pile.

On the other hand, both headline and core consumer prices in the euro area have rebounded, likely giving the central bank more confidence that inflation is returning to target. Indeed, comments from a number of policymakers strongly suggest that this week’s meeting will witness the ECB’s first formal discussion on ending QE.

Regardless of the ultimate decision this week (firm announcement or a heavy hint), we are likely to see the ECB face some tricky questions on Italy...and maybe reminded of that letter again!


LGIM contributors