Will Meloni Mellow?

Key points:

• The ECB’s TPI is unlikely to help Italy. How the parties likely to win the elections on 25 September frame their economic agenda is key.
• There is inertia in the central banks’ current hawkish stance, but signs of economic slowdown are accumulating on both sides of the Atlantic. This may affect the policy debate by the end of the summer.

The ECB chose to “rip the band aid” on negative rates and hiked by 50 bps despite fresh and unambiguous forward guidance in June that it would start with a 25 basis points. This may come with a permanent cost to credibility if the ECB decides in the future to offer forward guidance again. The Council probably saw the move as a worthy concession to the hawks to get unanimous backing for TPI, its new anti-fragmentation instrument. Still, while we see TPI as potentially powerful to offer protection to the rest of the periphery in case of contagion from Italy, we don’t think the new weapon helps to deal with the Italian drama itself. Even TPI’s “light conditionality” entails complying with some existing “contracts” with the EU which were at the heart of the tension within Draghi’s coalition. The message to Italy’s political circles is that for now, “they are on their own”.  How the parties likely to win the snap elections on 25 September amend their current manifestos will be key to curb any further spread widening. Giorgia Meloni – leader of Fratelli d’Italia, currently ahead in the polls in a right-wing coalition – has already toned down her Eurosceptic stance, but on tax and structural issues, radicalism still prevails.

The ECB is clear it wants to continue with normalization. We note however that for many economic agents in the Euro area, financial conditions are already restrictive – the latest Bank Lending Survey suggests lending standards are hardening fast. The flash PMI for July is consistent with a quick pace of deterioration in the real economy and the emergence of involuntary inventories may at last curb the current price dynamics. This may gradually offer some ground to the ECB doves, even if we think the next move in September will be at 50 bps as well.

This week we expect the Fed to hike by 75 bps. There as well adverse signs on the real economy are accumulating, but in the US initial overheating was obvious, which is likely to keep the Fed on a quite hawkish path for now.