The markets think that the new ECB tool to deal with bond stress could be similar to old tools.

London (Reuters) – Investors think that the European Central Bank might not need to come up with a completely new tool to ease tensions in the bond markets of the euro zone. Instead, they think it might be enough to put together the best parts of the tools it already has.

On Wednesday, the ECB said it would give more help and work on a possible new plan to stop a market sell-off that has raised fears of a new debt crisis in the southern part of the euro currency area.

Its statement caused the interest rates on 10-year loans in Italy and Greece to drop by up to 40 basis points, which was the biggest daily change for Greece since March 2020. In a week when yields across the bloc reached their highest levels in many years, the first reaction was relief.

So far, sources told Reuters late Wednesday that the ECB is likely to put some loose conditions on the plan.

The ECB will say that the goal of the plan is just to keep bond spreads in line with economic fundamentals. This will likely be done with quantitative benchmarks like historical spreads, which may then be turned into a “traffic light” system to tell staff which country’s bonds to buy and how much.

Patrick Krizan, a senior economist at Allianz, said, “I hope they have the smarts to make (a new tool) in a way that isn’t too strict, so that purchases can still be flexible” (ETR: ALVG).

“The biggest mistake they could make would be to be too dedicated and put themselves in a box.”

The ECB has already been criticised for not being careful enough about the risk that its plans to raise interest rates would make it more expensive for countries like Italy to borrow money than for Germany, which is seen as a safe haven.

Investors said that if the ECB comes up with a new tool to buy bonds, it needs to be flexible because the bloc has a clear problem with fragmentation.

So, just like the PEPP emergency stimulus plan during the pandemic, it would have to abandon the capital-key principle of buying bonds based on the size of an economy and instead buy debt from countries that need help the most.

GRAPHIC: Italy-Greece (https://fingfx.thomsonreuters.com/gfx/mkt/lgpdwbwyjvo/Pasted%20image%201655302743622.png)

One idea is to create a new tool like the Outright Monetary Transactions (OMT) scheme, which was used during a crisis but is no longer used. This scheme let anyone buy as much of a country’s debt as they wanted.

The main problem with the original OMT programme is that it requires countries to sign up for a bailout from the European Union, which often comes with terms that people don’t like.

“The political cost of the current OMT is quite high, so the ECB can’t do this alone. “There must be something on the political side to design an OMT-light that gives a country some protection,” Krizan said.

Analysts said that they thought a programme like OMT would have conditions, but not as strict as the ones in the first programme. Sources told Reuters that the new plan would have loose rules, like following the economic suggestions of the European Commission.

Antoine Bouvet, a senior rates strategist at ING Bank, said that the size and maturity of the bonds they will be looking at will be more important than fiscal requirements.

The original OMT programme was mainly about buying bonds with shorter terms.

Another option is to make a package similar to the Securities Markets Programme (SMP), which came before the OMT but didn’t have the strict, formal conditions of the OMT.

The good thing about the SMP was that it let the ECB buy bonds without adding to the stimulus that was already in the system. This is what economists call “sterilisation.”

Because of this, Francois Villeroy de Galhau, the head of France’s central bank, has said that sterilisation could come back to bond purchases.

Villeroy has said that the bank could also buy debt when the market is unstable and then slowly sell it as things get better. This would keep the bank’s balance sheet from getting bigger overall.

The SMP, on the other hand, was not very successful, and it ended with a value of only 209 billion euros, not long after Draghi’s July 2012 promise to do “whatever it takes.”

Still, Piet Christiansen, who is the chief analyst at Danske Bank, thinks that something similar to the SMP will happen.

“Sterilized purchases have been our baseline the whole time, and I think that’s to be expected, since the SMP programme was set up so that it doesn’t affect the monetary policy stance, and the only way they could do that was by sterilising the purchases,” he said.

Investors told the ECB that bond market relief would fade if it didn’t come up with detailed plans soon.

“At the end of the day, people want to see action,” Prime Partners’ chief investment officer, Francois Savary, said.