ECB’s Nagel warns crisis-tool use can lead to ‘dire straits’

In his first remarks on the matter since the ECB accelerated work on a crisis instrument, the German policymaker said officials should apply such measures only in “exceptional circumstances and under narrowly defined conditions.”

He also observed that it’s “virtually impossible” to establish whether a widened spread between euro-area members is justified.

“I would thus caution against using monetary-policy instruments to limit risk premia,” he said in a virtual speech to an event in Frankfurt. “One can easily find oneself in dire straits.”

Italy’s 10-year yield premium over its German counterpart – a key gauge of risk in the region – remained five basis points higher at 191 basis points after Nagel’s comments, having fallen to a seven-week low on Friday.

With the ECB’s first rate hike approaching, investors are questioning whether surging borrowing costs could force weaker nations into a repeat of last decade’s Europe’s sovereign-debt crisis. After Italian bond yields soared to a multi-year high in June, officials pledged to develop a tool to stem turmoil.

Nagel’s remarks are the most critical so far by a member of the ECB’s Governing Council. He warned that central banks “must not be driven by what are often very short-lived developments in the financial markets,” and that any instrument would need to be “clearly defined.”

At a minimum, he said, a potential tool would require clear justification on three points: Interest-rate spreads are fundamentally unjustified and reflect financial-market excesses; the transmission mechanism is impaired in individual countries; such effects are limiting the ECB’s ability to maintain price stability in the euro area.

Nagel also insisted that any activation of a tool should be “strictly temporary.” He added that an existing programme known as Outright Monetary Transactions – launched under former ECB president Mario Draghi – could be drawn on in principle.