Italy’s ‘no vote’: a rising challenge for the ECB?


The following guest post is courtesy of Ipek Ozkardeskaya, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).

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Ipek Ozkardeskaya, LCG
Ipek Ozkardeskaya, LCG

Italian populists said the last word on Sunday. Italy’s constitutional referendum, which was also a confidence vote for Prime Minister Matteo Renzi, has been rejected with 59%. Renzi resigned amid a heavy defeat.

The euro tanked to a 20-month low against the US dollar at Monday’s open. Italy’s no vote has been another nail in the coffin.

So far, 2016 has been a difficult year for the European Union. The UK’s decision to quit the European Union and Italy’s rejection of constitutional reform, has hammered sentiment at the heart of the Union. For sure, Donald Trump’s victory across the Atlantic has been a solid endorsement that the populist movement has spilled far beyond the region.

Austria’s rejection of the anti-immigrant populist Norbert Hofer has been the only slice of hope in the middle of a rising global anti-establishment movement.

Unfortunately, Europe may be heading towards tougher times in 2017. With German and French elections ahead, the political climate at the heart of the European Union could be spoilt.

Tough game for the European Central Bank 

The slippery political ground at the heart of the European Union is a substantial issue for the European Central Bank (ECB). President Mario Draghi needs the governments’ cooperation in boosting recovery and bringing back growth to the Eurozone’s depressed economy. At every speech, Mr Draghi has asked European policymakers to speed up structural reforms; otherwise monetary policy alone could not do miracles.

It is a sure thing that nowadays the Eurozone’s political environment is all but favourable for new reforms. Unfortunately though, the ECB is running out of time and resources. Perhaps having hit the bottom in terms of interest rate policy, the ECB is somewhat obliged to carry on with its broad-based sovereign and private asset purchases programme.

Yet it is possible that the bank is not perfectly comfortable with the asset purchases programme, given its impact on the sovereign markets and the perilously draining eligible assets. Over the last two monetary policy meetings, the ECB refrained from referring to the future of its monthly 80 billion euros worth of Quantitative Easing (QE) programme. The purchases are due to end on March 2017, but of course the ECB cannot simply let QE die. It would have major implications on the Eurozone’s liquidity and funding, even more so before the German and French elections, and perchance an early Italian election.

Therefore, the ECB has no choice other than finding ways to expand its programme beyond the first quarter of 2017. Although the pool of eligible assets is drying up at a dangerous speed, there are alternative ways of encountering the issue.

In this perspective, the ECB could make another shift towards corporate bonds, or simply expand the duration of the programme without making a quantitative commitment. The Bank of Japan has lately shifted to what is known as a qualitative programme, which aimed to target the long-term JGB yields. Fortunately, it did work. The ECB could, at its turn, aim for a similar strategy that would provide it with a greater intimacy, hence a broader power of action.

Markets for sure prefer a quantitative sovereign play due to its better visibility; nevertheless the risks of another quantitative intervention may be unnecessary. The heavy distortion in the Eurozone’s sovereign markets could only worsen with the rising political shenanigans at the heart of the continent.

How destabilising would it be for Italy to see the value of its debt further eroding against German debt? Wouldn’t it offer more power to the euro-sceptical Five Star Movement?

According to the Eurobarometer published by the European Commission in 2015, Italy’s euro-acceptance rate has been 49%, versus the Euro area’s already low average of 61%. This rate could have further deteriorated during the past year. If the Five Star Movement happens to gather enough momentum to propose a euro referendum, it is worthless telling how real the danger would be.

Therefore, wider yield spreads between the core and the periphery could only bring along higher tension and further erosion in sentiment across the Eurozone countries. Consequently, expanding the QE programme by at least three to six months, yet loosening the rules by setting up qualitative policy targets could be an alternative solution to keep investors back from amplifying the distortion in the critical sovereign environment at such politically challenging times.

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Italy’s 'no vote’: a rising challenge for the ECB?

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