Draghi resignation adds to the drama before key ECB meeting

Jul. 21, 2022 4:16 AM ETiShares MSCI Italy Capped ETF (EWI), FXE, EUO, ULEBy: Yoel Minkoff, SA News Editor13 Comments

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A big central bank meeting is on tap in Europe as inflation roils the continent and the euro remains on the backfoot. The ECB has been hesitant to get too aggressive on the monetary policy front - especially in comparison to the Federal Reserve - fearing a looming recession that was exacerbated by Russia's invasion of Ukraine. That stance may be changing, however, as the bloc clearly sees Moscow in the drivers seat in terms of natural gas supplies, and even higher energy prices that could put it further behind the inflation curve.

Bigger picture: While the Fed began its latest rate hike cycle back in March, the ECB has yet to raise rates as it sought to prioritize economic growth. In fact, the last time the central bank raised rates was in 2011, in the aftermath of the European debt crisis. Over the past few months, the ECB warmed to the idea by telegraphing a 25 basis point hike, though a bigger 50 bps move has not been ruled out and would be seen by the markets as a very hawkish signal.

Unlike the U.S., which makes up one large jurisdiction, the ECB's decision on Thursday will reverberate through 27 different member states and their economies. That could expose more indebted countries like Italy to financial trouble and weigh on peripheral bond yields as a whole. The situation remains even more precarious on word that Italian Prime Minister Mario Draghi (a former ECB president) will resign, prompting Italy's 10-year government bond yield to jump above 3.5% and the iShares MSCI Italy ETF (NYSEARCA:EWI) to slide 4.2% during Wednesday's session.

Anti-fragmentation tool: Seeking to limit the spreads between yields across the eurozone, the ECB is set to unveil a new stimulus plan during Thursday's meeting. Investors will be paying close attention to the details of the new bond-purchase program, including what assets policymakers are considering buying and under what circumstances. "While ECB President [Christine] Lagarde is likely to stress the temporary nature of the instrument - owing to the exceptional circumstances the euro area finds itself in - she will also underline the ECB's determination to secure the integrity of the monetary union, thereby trying to evoke a 'whatever it takes' spirit," wrote Dirk Schumacher, head of European macro research at Natixis.

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