Revenge of the Bundesbank spells serious trouble for Italy - The Telegraph - 02.09.22

The real danger for Italy is that it might be asphyxiated slowly by untenable borrowing costs says Ambrose Evans-Pritchard.


The European Central Bank can either bail out Italy or save its credibility in Germany. It will struggle to do both.


With inflation running at a fifty-year high in Germany, 14pc in the Netherlands, and 25pc in Estonia, it is politically impossible to keep mopping up Italy’s debt issuance under the guise of monetary policy. The euro’s crash to dollar parity has been the last straw. The Bundesbank has lost patience.


The ECB is in the worst internal disarray since the depths of the eurozone debt crisis. Hawks and doves are contradicting each other daily on fundamental strategy. Markets have no idea how the new ‘anti-spread’ tool (TPI) to protect Italy is supposed to work, or whether it is legal outside an emergency.


“It is a complete shambles. Christine Lagarde has lost control and is not showing any leadership,” said one source close to the Bundesbank.


Mrs Lagarde did not attend the central bankers’ forum in Jackson Hole. The vacuum has been filled by Isabel Schnabel, Germany’s member of the executive council, who has returned to her Bundesbank roots after a fateful dalliance with ultra-loose money.


“Our currencies are stable because people trust that we will preserve their purchasing power. Failing to honour this trust may carry large political costs,” she said at Jackson Hole.


“History is full of examples of high and persistent inflation causing social unrest. Sudden and large losses in purchasing power can test even stable democracies,” she said.


Mrs Schnabel said the movers and shakers in finance no longer believe the ECB’s assurances. They suspect that it will always prefer to let inflation ratchet upwards rather than sacrificing growth, if forced to choose. “Determined action is needed to break these perceptions,” she said.


Her speech was a thunderclap. She said it was “largely irrelevant” whether the surge in inflation is caused by an external supply shock or internal demand. The institution must take pre-emptive action to head off the risk of self-feeding inflationary spiral as an insurance policy, even if this might mean monetary overkill.


It must engineer a recession now to avoid something worse later. This is the voice of the old Bundesbank.


It was an explicit warning that the ECB would no longer set policy to cap the bond yields of vulnerable states. Hedge funds could hardly receive a clearer invitation to revive the ‘short Italy’ trade.


“We’ve been short since the beginning of the year. It seemed like Italy’s problems had gone away but that was only because the ECB was buying more than 100pc of net debt supply. They can’t keep doing that now,” said Mark Dowding from BlueBay Asset Management.


The International Monetary Fund said in its latest ‘Article IV’ report that foreigners have pulled a net €70bn out of Italy over the last six months. It warned of a “vicious cycle between the sovereign and banks” as yields rise on Italian debt.


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It is an awkward political moment for the ECB to be ripping away Italy’s debt shield Credit: Michael Probst /AP

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