RPT-COLUMN-Will ECB be left holding central bank 'independence' baton?: Dolan

By Mike Dolan

LONDON, Sept 9 (Reuters) - If central bank independence is all it's cracked up to be, then the European Central Bank may be in a good spot, as its odd multinational structure likely leaves it better protected from political interference gnawing at its peers. Whether it proves a boon or a drag is an open question.

U.S. President Donald Trump's administration is already seeking to reshape the structure and remit of the Federal Reserve, long a standard bearer for effective economic management. Many investors suspect the process is both inevitable and damaging.

Whatever the public rationale for more political influence over the once fiercely independent institution, the suspicion is that the extraordinarily high U.S. public debt means Washington needs the Fed to play ball by keeping interest servicing costs manageable.

The U.S. central bank's ability to accomplish that task without compromising control of inflation, which is still above its 2% target, is what has been unnerving the long end of the bond market and, arguably, the dollar exchange rate.

Washington may not be alone in this central bank rethink.

Japan's ruling Liberal Democratic Party is moving to select a new prime minister after the resignation of Shigeru Ishiba, and the current favorite to take the role, LDP veteran Sanae Takaichi, is opposed to the Bank of Japan's desire to push interest rates higher and has advocated greater co-ordination between the BOJ's monetary policy and government fiscal policies.

The BOJ's political independence may already be tenuous relative to its Group of Seven peers, of course, but the direction of travel in highly indebted Japan is not lost on edgy world bond markets.

The Bank of England, whose operational independence is less than 30 years old, may seem more secure. But British debt pressures are building too and the BoE's relatively tight relationship with government on its inflation target and balance sheet usage sees it rank relatively low on the G7 list of central bank autonomy.

That then leaves the ECB. Its complex-multinational structure was once seen as its Achilles' heel, but its long-criticized bureaucracy may actually be excellent armor against attempts at government capture.

CAN'T HAPPEN HERE

All G7 central banks are ultimately arms of government, of course. However, direct political influence over interest rate setting has been shunned for decades to avoid compromising inflation control with the feverish demands of electoral cycles.

The very perception of that distance has been important for monetary policymakers seeking to maintain market credibility regarding their pursuit of stable prices over the long term.

But history shows that when extraordinary financial, economic or even military crises dictate, central banks clearly prioritize stability over all other concerns and are therefore willing to facilitate massive government borrowing when needed. The COVID-19 pandemic of 2020 is the most recent example.

The question now is whether developed nations' historically high public debt loads and the unwillingness of governments - or electorates - to rein them in constitute a "crisis" of those proportions.

Optically at least, the ECB appears better protected, as none of its constituent member governments can exert the kind of control seen in Washington, Tokyo or even London.

Additionally, the ECB's autonomy to control inflation is rooted in its constitution and treaties, rather than easily changeable laws or Treasury guidance.

In some eyes, ECB independence was partially blurred by the euro government bond-buying efforts in the 2010s.

With the eurozone facing its own existential crisis in 2010-2012, the ECB proved adept at finding wiggle room in what were originally viewed as prohibitions on government debt support as it gobbled up government bonds to prevent the euro's collapse.

And its more recent commitment to smoothing monetary policy transmission across the bloc gives it leeway to address "excessive" gaps between sovereign bonds within the zone.

But direct political capture by any one of its members - along the lines being discussed in Washington, for example - currently seems far fetched.

"In terms of the institution, the ECB is better protected than the Fed," Francesco Papadia, a former ECB official who is now a senior fellow at Bruegel, said last week. "What is happening in the United States could never happen in Europe."

As a test of this notion, it continues to reduce its balance of bonds even as debt tensions rumble again in France.

MEDAL OR MILLSTONE?

The two main market consequences of messing with central bank independence are hot inflation expectations, steeper government yield curves and high long-term debt costs on the one hand and a weaker currency on the other. On those metrics, the jury appears out so far.

Even though Washington is the center of the storm right now, European yield curves are actually steeper - even if nominal long-term yields are lower and inflation is already back at the ECB's 2% target.

However, the euro has surged 13% against the dollar this year and could well be supercharged going forward - itself a dubious pleasure for a region with still meager economic growth and facing higher U.S. trade tariffs to boot. The Swiss National Bank's battle with franc strength and deflation is a far smaller but curious example.

Even though the ECB has embraced greater use of a "global euro" to help with the multiple heavy financing needs of the region, some of its officials have been uncomfortable about excessive euro appreciation beyond current levels.

If the ECB were the last truly independent central bank left standing, it could ultimately be vulnerable to losing support at home if rival countries steal a march with a growth push and fiscal largesse.

Whether greater market credibility can ultimately leave European voters better off than their peers in countries less finicky about central bank independence may then determine whether this adherence to rules is a badge of honor or a millstone.

The opinions expressed here are those of the author, a columnist for Reuters

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