Due to the war, fragmentation risks have also resurfaced. This could impair the uniform transmission of the current policy setting. There are no urgent signs of stress, but if fragmentation materialises, the ECB already has the instruments available to deal with this. So far, markets have remained relatively calm in light of the recent events in the Middle East, and we see no need for immediate policy action. Italian spreads have been increasing over the past two months, but they are not yet at the levels seen last year (although the comparison today is to a significantly higher Bund yield, leaving outright BTP yields at their highest since the days of the sovereign debt crisis). Nonetheless, a new bout of risk aversion could impair policy transmission. Firstly, safe haven demand may benefit Bund yields, which in turn could lessen the impact of policy tightening to date – to the extent that this isn’t offset by an increase in credit spreads. Secondly, assuming that risk aversion would also cause further widening of Eurozone sovereign spreads, financial conditions across the currency union would not be affected uniformly. If asked, we expect Lagarde to remind journalists and markets that the ECB already has developed the tools for the eventuality of fragmentation, in the form of flexible PEPP reinvestments and – in the absolute worst case – the Transmission Protection Instrument. - Rabobank
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