Markus Nagel criticizes Christine Lagarde's ability to solve the Eurozone crisis

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The days of European Central Bank cooperation that were started by Christine Lagarde may be coming to an end, as a Bundesbank warning shot on her crisis policies evokes its prior role as the thorn in the presidency’s side.

The statement by German official Joachim Nagel, warning that an anti-turmoil tool is dangerous, is increasing the heat as discussions intensify on a key element of ECB chief Mario Draghi’s plans to raise interest rates.

If a crisis similar to the one that Mario Draghi faced during the sovereign-debt crisis a decade ago occurs, Lagarde might have to execute a tricky policy maneuver fraught with market turmoil. She would also have to be concerned about Germany's central bank, which could be critical.

"The comments reflect the difficulty in designing such a tool," said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. "It may also be due to politics, since you have to sell the tool at home. The president of the Bundesbank has to state his objections."

The sudden departure last year of Weidmann’s predecessor, Jens Nagel, indicated that there were problems. Until now, when speaking publicly about ECB policy, the new Bundesbank president had been more diplomatic in his tone.

The Governing Council's pledge to develop a crisis tool that would allow interest rates to rise as the Bundesbank wished, following the debt market turmoil in June that was centered in Italy, was triggered by the outbreak of the financial market turmoil.

Strict Terms

In his speech, Nagel implies that the likely form of an anti-turmoil measure, and Lagarde's quick change in position, may have been too much to bear.

"The financial markets are not a good indicator of what monetary policy should be," he said. "Unusual monetary policy measures can be justified in exceptional circumstances, and only under narrowly-defined conditions."

Nagel outlined the conditions under which a tool like this could be considered acceptable, the situations in which it could be used with good conscience, and the warning that if those conditions are not met, "you might find yourself in serious trouble."

Germany’s constitutional court raised a legal concern about the bond purchases, and this language was in line with it.

Later that day, Luis de Guindos, vice president of the ECB, reassured the audience at his own speech at the same conference that any use of a tool wouldn’t be random. He suggested that any measure would be appropriate.

"We will take appropriate measures to prevent the spread of damage, while taking care not to create an incentive for more reckless behavior," he said.

The tool introduced by the ECB could easily meet the requirements that Nagel outlined, but his comments may well trigger serious disagreements in the future.

In the Bundesbank chief’s speech, market analysts were able to get a glimpse of the hawks' "red lines." However, such conditions can assist in supporting the ECB's credibility and prevent market turmoil in the future, Allianz SE economist Katharina Utermoehl said. "After all, it would be pointless to introduce a spread-fighting tool that has only a short lifespan," she concluded. 

The Bundesbank, which was established in 1958, is one of the most important financial institutions in Germany.

Nagel's intervention is part of his institution's long tradition of seeing itself as a guardian of price stability, which was modeled on the ECB. This role prohibits monetary financing, which is enshrined in an EU treaty.

In the face of that background, Bundesbankers have often protested ECB policies. One president, Axel Weber, resigned in 2011 as the euro-zone central bank acquired bonds of crisis-stricken countries such as Greece. Juergen Stark, the ECB chief economist and a former Bundesbank official, resigned later that year.

Weidmann, who took over from Weber when he retired, opposed the OMT tool that Draghi introduced in 2012. He later acknowledged its legitimacy when he himself was candidate to lead the ECB.

When Lagarde became president, she adopted a different approach than that of Draghi. Weidmann and Nagel largely went along with her.

In an interview shortly before taking office in 2019, she explained her priority as "making sure that we are a team, that we disagree with one another and then, once the disagreement is settled, once there is a common line, that we all move together."

It is hard to reconcile Nagel's public statement with that approach. This incident does not yet signify a total breakdown in relations, but the possibility that German public opinion might become aware of it is now on the horizon.