How can the ECB deal with the risk of fragmentation?

The ECB is preparing a new programme to limit divergences in borrowing costs within the euro area. This Policy Insights paper argues that this so-called ‘anti-fragmentation’ tool needs to be seen in conjunction with the existing tool, namely the Outright Monetary Transactions (OMT), created by the ECB under Mario Draghi in 2012 and widely credited with ending the euro crisis. Although the OMT was never used, it remains available to this day. This paper also argues that high spreads are less of a concern if confined to long-term debt, as short-term spreads signal more imminent risks and translate more quickly into higher debt service costs. The new ECB tool should thus be seen as constituting a first line of defence, concentrated on limited amounts on longer maturities. If this is not sufficient, countries with sound fundamentals may ‘buy insurance’ by using the ESM precautionary line – whose pre-set conditions are now broadly set – to unlock OMT, allowing for unlimited interventions, including at shorter maturities.