By now it should be clear that monetary policy cannot cure coronavirus. But central bankers can certainly aggravate the market symptoms.
That is the accusation being levelled at Christine Lagarde after a remark she made last week that triggered a sell-off in parts of Europe’s bond markets. It is not the European Central Bank’s job, the president said, to “close the spread” between the bonds of different member states.
Clearly, some traders thought it was, judging from the subsequent slide in Italian debt.
Despite an apology to her colleagues, and some swift backpedalling in public, borrowing costs continue to rise. Italian 10-year yields hit a nine-month high of more than 2.3 per cent on Tuesday, which is the last thing Rome needs as it considers extra spending to try to contain the pandemic crisis. Just two weeks ago, Italy could borrow for a decade at just 1 per cent.
Perhaps even more worrying are the echoes of the eurozone debt crisis: Greek, Portuguese and Spanish bonds have weakened in sympathy with Italy. Yield levels are still far below the peaks of over 7 per cent reached in 2012, but still, the concerns are clear.
Much of the gnashing of teeth in markets is pure self-interest. Many investors will be sitting on big bets on Italian government bonds that have soured over the past week. But regardless of their motives, these investors are the people the ECB needs to convince if it wants to prevent borrowing costs from spiralling upwards.
In a sense, what Ms Lagarde said last week was true: the ECB has no direct mandate to control spreads, at least until they start to impair the functioning of monetary policy. Mario Draghi’s famous 2012 assertion that he would do “whatever it takes” to save the euro always came with caveats.
But the episode showed that Ms Lagarde, a former lawyer, lacks the sensitivity to markets of her predecessor. Bear in mind that Mr Draghi, a former banker, had succeeded in convincing people of the power of a bond-market rescue package without ever actually using it.
For Ms Lagarde, halting the march higher in yields is likely to require an open-ended pledge from the ECB to buy bonds. Markets have clearly already decided that last week’s extra €120bn of asset purchases this year (on top of the monthly €20bn already in place) will not be enough.
The current slide in Italian debt, in fact, may force the ECB to relax its self-imposed rule to buy no more than one third of any country’s bonds.
“There’s reason to think that something good will come out of this and it will force a bold decision on the issuer limits,” said Frederik Ducrozet, a strategist at Pictet Wealth Management. “That’s the fastest way to demonstrate to the market that the commitment is there.”
If Ms Lagarde’s slip-up proves one thing, it is that central bankers’ words and actions still matter.