The European Central Bank surprised markets on September 6 with a bold bond-buying initiative designed to take some of the pressure off the struggling, peripheral euro zone. Having promised in recent weeks that it would do all it could to save the euro, the ECB, by some accounts, was now delivering.
Equity markets in Europe hit 2012 peaks, while news of the ECB’s move helped take the Dow Jones Index to the highest level since the collapse of Lehman Brothers in 2008. The euro rallied against the dollar, lifting it from $1.26 to more than $1.285. More to the point, bond yields in Spain and Italy fell sharply.
But despite the euphoric headlines — not least the ones referring to ECB president Mario Draghi as “Super Mario” — there are some doubts about what the ECB’s pronouncements will mean in practice.
The ECB said it will buy sovereign bonds in the secondary market in a process known as “outright monetary transactions” (OMT). While not providing any fresh cash for beleaguered countries, it does provide support in the market that ought to reduce the yields at least to some extent, and hence cut these countries’ cost of borrowing. The bank will buy bonds predominantly (but not, apparently, exclusively) in the one year-to-three-year maturity range (including longer-dated bonds with 12–36 months left to run).
The ECB has lent the whole exercise an air of mystery by refusing to say how much money it is prepared to commit and by not giving any indication as to when it will intervene in the market to buy bonds. It will not publish any interest-rate targets, nor discuss what it would regard as desirable spreads over German rates.
Draghi hinted at the press conference, however, that not only were peripheral countries’ rates too high, but Germany’s were too low: “If bond markets are distorted in the euro area, they are distorted in all directions,” he said. He also said that, in deciding when to intervene, the ECB would be looking at a range of indicators, such as credit-default-swap spreads, liquidity measures like bid-ask spreads, and volatility.
Analysts at Deutsche Bank described the move as “one big leap forward” in a note to clients and endorsed the ECB’s stance: “To be efficient, investors must be certain of the policymaker’s commitment, but uncertain on the precise modalities of intervention. In other words, the central bank must maintain complete discretion on the timing and dosage of the purchases.”
The ECB governing council comprises six executive members plus the heads of the central banks of each of the 17 euro member states. There was only one dissenting voice on the governing council. Draghi wouldn’t name him, saying only, “It is up to you to guess.” But there are no prizes for guessing that the dissenter was Jens Weidmann, president of Deutsche Bundesbank.
But while some headlines in Germany have proclaimed the OMT move as “the death of the Bundesbank,” the policy isn’t perhaps the blank check that some have feared — or hoped for. The conditions that attach to the bond-buying program may make it less effective than initially expected.
For one thing, countries will only qualify for OMT support if they have applied for help from the European Financial Stability Facility (EFSF) or its intended successor, the European Stability Mechanism (ESM). Spain and Italy haven’t yet done so, for example. More to the point, qualifying countries must be abiding by EFSF/ESM austerity conditions, and Draghi said that the International Monetary Fund is “more than welcome” to be involved in “the design of the policy conditionality.”
Draghi made it clear: “Governments have to undertake the policy reforms. We are convinced that no intervention by this or any central bank is actually effective without concurrent policy action by governments.” So this is no central bank silver bullet. In fact, it’s back in the lap of the politicians to sort out the real mess.
Further, analysts at Moody’s said in a recent research report that “There is little in the initiative that is fundamentally new.” They pointed to an earlier, discontinued Securities Market Programme and added that the fiscal conditions attaching to the new program are actually no stricter than they currently are.
Moody’s adds that the ECB’s “actions can ultimately do no more than buy time, as its decision to focus on short-term debt purchases implicitly recognises.”
It isn’t even certain that Spain or Italy will make the necessary application for bailout support. Neither is Bank of America Merrill Lynch, on balance, swayed by the rhetoric. Analyst Ralf Preusser said in his note to clients that, because of the emphasis on “conditionality” attaching to the OMT program, “the hurdle for such an application has increased today,” though Spain and Italy have, between them, €526 billion of debt maturing over the next 1–3 years.
Andrew Sawers is editor of CFO European Briefing, a CFO online publication.