The ECB's Message to Italy: No Free-Riders Allowed

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The European Central Bank is back in the spotlight with a series of speeches by key Governing Council members suggesting next week's meeting will herald an important announcement as to the ending of the Bank's quantitative easing programme.

Comments on the matter from various ECB members has seen the Euro rally against a host of major currencies, as the ending of quantitative easing is widely seen as being supportive of the currency.

But, pne significant question for markets was whether the ECB would delay an announcement on ending quantitative easing, in light of fresh political uncertainty in Italy where an apparently Eurosceptic and free-spending government has just taken power.

There are concerns that the new government's policies will ultimately lead to a significant deterioration in Italian finances to the extend that the Italian economy and financial system becomes destabilising to the wider Euro system.

The thinking goes that ending the quantitative easing programme, which has been pivotal in supporting the Eurozone economic recovery and making government debts manageable, might best be dedlayed until the Italian picture becomes clearer.

But, BofAML's Moec reckons the ECB are sending an important message: the ECB will not be taken hostage by populist governments.

"We think there is a key political message here," says Moec. "QE was always based on an implicit contract with national governments, which were supposed to deliver fiscal prudence and structural reforms in exchange for monetary support. ‎This is no longer obvious, given the stance of the new Italian government."

Moec says there was always a risk that QE would allow "free riding" behaviour.

"This is materialising now. Closing the QE chapter a week after populists come to power in Rome signals the ECB's unwillingness to allow its monetary policy to be taken"taken hostage". Also, as we wrote last week, Italy is "on its own" and the ECB does not seem inclined to help control the spread widening," adds the analyst.

BofAML say they ‎expect them to announce a short taper to December next week.

"This doesn't mean we'll have everything we need from the ECB on their monetary stance. The end of QE was in any case well expected. There is some information content in the choice of the moment for communicating it, but the real issue is on how forward guidance on policy rates will evolve. On this, we think we'll have to wait a bit longer, probably July, with possibly some snippets at Sintra," says Moec.

The ECB's conference of central bankers in Sintra, Portugal tends to coincide with major policy announcements; last year we saw what appeared to be a coordinated message from central bankers suggesting they would be withdrawing their monetary support.

Expect further significant announcements at this year's event which runs from June 18-20.

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