TPI as a new crisis tool (To Protect Italy)..
What is the TPI program Of course, its meaning is not as in the title, but this is the name given by the economics circles. In fact, it is Transmission Protection Instrument. Lagarde announced this financial instrument for use in times of crisis, which they hope will ensure that markets do not raise borrowing costs too aggressively in fragile economies, as the euro’s existence was questioned in 2012. The TPI is designed as an instrument to support the return of inflation to its medium-term target by strengthening the anchoring of inflation expectations and adjusting demand conditions to reach the inflation target in the medium term. In simple terms; The TPI is a new bond-buying scheme aimed at helping more indebted eurozone countries and preventing financial fragmentation within the currency bloc.
The purpose of the program The ECB’s rate hikes increase borrowing costs inside the currency bloc, meaning that countries like Italy, Spain and Portugal could see a larger increase in their yields than “solid” members like Germany and France. Italy, which has a lot of debt and is caught in a government crisis, is particularly vulnerable as markets fear a prolonged period of political instability. The ECB has hiked rates for the first time in more than a decade and has also signaled further increases, so the southern part of the bloc (PIGS – Portugal, Italy, Greece, Spain) could potentially face a large increase in borrowing costs in the coming months.
Criteria If we look at the criteria Lagarde has listed for this TPI instrument, which is normally open to all Eurozone members;
Compliance with EU financial rules,
Not excessive macroeconomic imbalances
Fiscal sustainability, where institutions such as the IMF, European Commission and European Stability Mechanism will be consulted,
Implementing sound policies
The TPI will be an addition to the existing ECB toolkit. The ECB says reinvestment from the Pandemic Emergency Purchase Program (PEPP) will remain the “first line of defense” against transmission risks. In TPI, purchases will focus on public sector securities with remaining maturities between 1 and 10 years. Private sector securities may be considered, if appropriate. Market conditions will show whether it is viable or effective.
There is a possibility that the instability that started in Italy will increase, but how to avoid the effect of economic asymmetry and if macroeconomic stability will be a prerequisite then will the TPI really need to be used? It seems that the government crisis will increase Italy’s bond yields and we will watch the opening effect in the Italian-German spread. Plus, a fiscal plan will need to be submitted, as in IMF stand-by agreements or the bailouts to Greece.
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Italian-German 10-year bond rates and spread development
Conclusion? Bond markets seem not to be convinced of the new instrument at this stage, as the spread continues to increase above the 230 bps level. Reinvestments under PEPP will be the balance instrument that the ECB will primarily use for spread control, while TPI can be thought of as an emergency button.
Government bonds will be included in the TPI portfolio first, followed by private sector bonds if necessary. It is not known to what extent speculative pressure will be in market-based borrowing costs. Therefore, it may be the case that emergency purchases cause a balance sheet asset inflation that would render the effect of rate hikes meaningless. The risk elements of European financial assets have increased considerably. There is an increase in the risk premiums for which the CDS indicator is taken for the company and the bank. It will be difficult for the euro to strengthen in such a profile.
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