M&G's Isaacs: Why would the ECB run the risk of tightening?

The ECB is expected to end its three-year bond buying programme this September but concerns over liquidity are now prompting commentators to question whether it could be extended. 

The financial markets have been affected by the political fallout in Italy, with yield spreads between Italian and German 10-year government bonds widening 2.53 percentage points on 29 May, the highest level since 2013.

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Central bank president Mario Draghi has said the programme could be extended beyond September "if necessary" and a decision is likely to be made when the ECB meets on 14 June.

Isaacs, who is also deputy head of retail fixed interest, said the ECB had little "firepower" available to it. 

"Given the lack of fiscal firepower available to eurozone governments, the ECB finds itself in an unenviable position. The onus remains on easy monetary policy to support economic growth in the eurozone and the ECB is best served by erring on the side of caution.

"There will be some members who feel the risk/reward is skewed to the other direction and the risk of financial instability means they need to tighten and hope the market can stomach it. But I think they will take their time and can be gradual."

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Isaacs said a major point affecting the decision would be whether tightening would cause a slowdown and if the ECB would be able to cope with this.

Arnaud Marés at Citigroup, a former special advisor to Mario Draghi, has argued a central bank requires 300-400bps of rate cuts to be confident they can suitably stimulate an economy in the face of a significant economic slowdown.

"Inflation is still below target, why would they run the risk of tightening and causing a slowdown which they then cannot respond to? Further rate cuts would do more harm than good," Isaacs added.

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