The ECB introduced a new tool to navigate markets better

The European Central Bank (ECB) decided to surprise markets with a higher-than-expected rate hike on Thursday by 0.5% instead of 0.25% as expected. Along with the rate hike, the ECB also introduced a new anti-fragmentation tool to keep bond markets in check. So what is TPI?

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Transmission Protection Instrument (TPI) explained

The ECB introduced a new policy tool alongside the 0.5 % interest rate increase. TPI will focus on limiting the divergence in borrowing costs across all the countries in the Eurozone, as these costs are becoming a significant problem. Moreover, it aims to halt erratic government bond market moves. In other words, the new “financial weapon” will enable the ECB to purchase bonds from nations where it deems financing circumstances have unjustifiably deteriorated. 

According to the bank, there are no restrictions on the size of the bond purchases, which will be determined by how serious the risks are. The ECB claimed to buy public debt with maturities ranging from one to ten years and that this tool allows them to raise interest rates more over time. There is optimism that simply announcing the tool would be enough to calm bond markets and prevent it from ever being needed. The ECB’s president, Christine Lagarde, stated:

“I can assure you that we would rather not use” the tool. “But if we have to use it, we will not hesitate.” 

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If they were ever to use this tool, the Governing Council, made out of 25 members, would have to approve it first. There are 19 heads of central banks of every country in the Eurozone and six people on the executive board who make Governing Council. Countries would have to fulfil specific requirements to take advantage of the policy tool. These could include a manageable public debt trajectory and an economically maintainable economic strategy.

The TPI will be an extension of the current set of tools of the ECB. Outright Monetary Transactions (OMT) will continue as necessary, and reinvestment from the Pandemic Emergency Purchase Programme (PEPP) will continue to be the “first line of defense” against transmission concerns, according to the ECB.

Conclusion

This introduction of TPI could bring a new era, and the mission to bring the borrowing costs down will be successful. However, only time will tell. Hopefully, ECB will no have to use it, as the ECB’s president stated.