When the Federal Reserve delivered its bumper 75 basis point interest rate rise last week it had enough on its plate balancing the need to control inflation against the risk of recession.
The European Central Bank ( ECB) has to balance similar priorities and, unlike the Fed, it also has to worry about a single currency area in which a French bond is different from an Irish bond and, most of all, an Italian bond is different from a German bond.
So, even before the central bank had started to raise interest rates, which have been negative for eight years, it was fretting about Italy and the sustainability of a debt load that is equal to 150pc of gross domestic product. That’s even higher than it was during the euro crisis.
The sensitivity of Italy to spreads – the risk premium investors want to be paid for holding its bonds over Germany’s – and to rising interest rates is, according to hedge fund manager, author and economist Eric Lonergan, ‘chronic’.
This is down to a problem we have known about ever since the euro was created and it is one that creates instability at the heart of the project.
It means the currency bloc has failed to live up to the pledges made to its citizens to deliver more dynamic economic growth, more jobs and better wages.
“The crux of the problem is that sovereign debt is issued by national member states and money is created by a supranational entity – the ECB,” Mr Lonergan told Bloomberg in a recent interview.
So this is how we ended up with the ECB saying it was finally ending new purchases of euro area government bonds after it bought 80pc of overall issuance in the last two years and 120pc of Italy’s, and then calling a panicked meeting last week to try and work out a way to deal with the risks of an Italian debt and a banking doom loop caused by rising interest rates and self-reinforcing market rout.
We have gone from the ‘we’re all in it together’ optimism of the Next Generation EU coronabonds in March 2020 – which opened a potential path to the more widespread us of a common debt instrument – to one in which Ireland’s own Paschal Donohoe as the head of the Eurogroup finance ministers was forced to admit last week that plans for a eurozone banking and capital markets union, key anti-crisis tools, had failed.
Once again, national self-interest had trumped solidarity. In a bid to put some kind of gloss on the failure, an EU official insisted to Reuters that the banking union is “certainly not dead, it's taking a nap for a little while”.
The finance ministers themselves must have been napping to miss a speech by ECB board member Isabel Schnabel just two days before their meeting in which she laid the ground for the creation of a new facility at the central bank so as to prevent Italy’s debt from becoming unmanageable due to rising spreads.
Governments, she said, needed to take “further steps” to complete the banking and capital markets union and to create “a permanent fiscal tool at European level, as well as by creating a euro area safe asset”.
In the meantime, the ECB was there to close the spreads, or as Ms Schnabel put it more elegantly: “Monetary policy will need to respond to destabilising market dynamics.”
So here we are again, back to the ECB backstopping the inbuilt fragilities of the eurozone. It’s as if nothing has really changed since former bank president Mario Draghi’s “whatever it takes” speech from 2012.
That leaves the bloc stuck in ‘muddling through mode’ once again with the Stability and Growth Pact debt and deficit rules remaining suspended through next year, but no meaningful progress on reform.
The political infighting that killed off the banking and capital markets union last week is also going to surface in negotiations over the creation of the ECB’s new anti-fragmentation tool. Some German economists are already dubbing it a backdoor bailout for Italy.
Unsurprisingly, Italian officials have suggested the new facility be activated at a relatively low level, when its debt is yielding 150 basis points (1.5 percentage points) over German debt. The ECB itself introduced its pandemic bonds programme at a time when Italian yields were 300bps over German.
To be sure, when you have been holding the eurozone together for the past decade you have plenty of experience of designing tools to prevent market panic. The best option would be for the ECB to say it would buy bonds in unlimited amounts; the worst would believe that verbal intervention alone would suffice.
If the ECB is swift and decisive it may end up conserving its financial firepower, but the longer talks go on and the more interventions there are from the bank’s 25 decision makers, then the greater the uncertainty and the greater the potential cost to the bank, to Italy and to the eurozone.
"All told, we think the new anti-fragmentation tool may take many weeks to agree,” says Andrew Kenningham of Capital Economics.
"It may require another sell-off in peripheral bond markets before the ECB agrees the details of its latest variant of quantitative easing.”
There’s only one real path to end the destabilising dynamics of the eurozone and the need for repeated ECB bond market interventions, especially with the impact of a war in Europe, says Shahin Vallee of the The German Council on Foreign Relations.
"The ECB must own this argument fully and formally call for further fiscal integration in the form of new borrowing and spending to achieve energy independence and enhance European security and defence capacities,” he wrote.
At the same meeting at which Mr Donohoe had to admit defeat on the banking and capital markets union, he also hailed “Croatia’s path to becoming the 20th member of our euro area” as “a strong signal for European integration”.
It would be a great shame if, as Croatia entered through the front door, Italy was being shuffled out of the back after running large primary budget surpluses from 2011-2019 after which Covid hit.