Draghi gets ECB backing for unlimited bond-buying

FRANKFURT Thu Sep 6, 2012 4:16pm EDT

European Central Bank (ECB) President Mario Draghi smiles as he speaks during the monthly news conference in Frankfurt September 6, 2012. REUTERS/Alex Domanski

European Central Bank (ECB) President Mario Draghi smiles as he speaks during the monthly news conference in Frankfurt September 6, 2012.

Credit: Reuters/Alex Domanski

FRANKFURT (Reuters) - The European Central Bank agreed on Thursday to launch a new and potentially unlimited bond-buying program to lower struggling euro zone countries' borrowing costs and draw a line under the debt crisis.

Seeking to back up his July pledge to do whatever it takes to preserve the euro, ECB President Mario Draghi said the new plan, aimed at the secondary market, would address bond market distortions and "unfounded" fears of investors about the survival of the euro.

The scheme, to which Germany's Bundesbank reiterated its opposition, would focus on bonds maturing within three years and was strictly within the ECB's mandate, Draghi said. Only one member of the ECB Governing Council had dissented, he said.

"Under appropriate conditions, we will have a fully effective backstop to prevent potentially destructive scenarios," Draghi told a news conference after the central bank's monthly meeting On Thursday.

"No ex-ante quantitative limits are set on the size of outright monetary transactions," he said, using the formal term for ECB bond-buying programs.

Investors were on tenterhooks, waiting to hear how decisively the ECB would act to help bring down the borrowing costs of Spain and Italy, after disagreements among policymakers on the plan were played out in public last week.

Draghi's statement at least met expectations, analysts said. With the bond-buying plan the focus of Thursday's meeting, the ECB kept interest rates on hold, leaving its main rate unchanged at 0.75 percent.

"The details ... released today add to the credibility of the safety net taking shape in the euro zone and should support demand for euro zone assets," said Andrew Cox, G10 strategist at CitiFX in New York.

Euro zone blue chip stocks soared 3.2 percent to levels not seen since March in response.

Pressure on Draghi intensified after an unsubstantiated German newspaper report last week that Bundesbank chief Jens Weidmann had considered resigning over his opposition to bond-buying, although several sources say he has made no such threat and believes in staying at the table to argue his case.

Draghi succeeded in securing overwhelming support on the Governing Council for the plan despite Weidmann's opposition.

"In the most recent discussions, as before, Bundesbank President Jens Weidmann reiterated his frequently substantiated critical stance towards the purchase of government bonds," the German central bank said in a statement.

"He regards such purchases as being tantamount to financing governments by printing banknotes," it added.

Other ECB policymakers saw a greater urgency to help Spain and Italy and prevent the euro zone crisis from deepening.

STRICT CONDITIONS

Draghi said the ECB would only help countries that signed up to and implemented strict policy conditions, with the euro zone's rescue fund also buying their bonds, and preferably with the IMF involved in designing and monitoring the conditions.

Renewed ECB intervention in the euro zone's bond markets is crucial to buy governments time to come up with a longer-term response to the bloc's debt crisis, which began in early 2010.

Spanish and Italian government bond yields have fallen significantly since Draghi said on August 2 that the ECB would buy bonds issued by Madrid and Rome. They fell further after he fleshed out his plan to intervene on Thursday.

The ECB would not target specific bond yields, Draghi said.

ECB debt purchases - which would succeed the bank's Securities Markets Programme that has been dormant since March - would be suspended if countries did not comply with the terms.

With Germany's constitutional court not due to rule on the new ESM rescue fund until next week, there was no prospect of the ECB intervening immediately.

Highlighting the euro zone's economic predicament, Draghi said growth in the region would recover only gradually. Fresh ECB staff projections pointed to the economy contracting this year by between 0.2 and 0.6 percentage points.

One downside for policymakers may be an increase in commodity prices, which were buoyed by the ECB announcement. Brent crude oil gained rose $1.50 on Thursday to $114.59 a barrel and wheat rose 8 cents a bushel to $8.54.

NO SENIORITY

Draghi also said the ECB was prepared to waive its senior creditor status on bonds it purchased - meaning it would be treated equally with private creditors in case of default.

The central bank hopes that by removing private investors' concern about being paid back last in the event of a sovereign default, they will not head for the exits if the ECB intervenes and buys bonds.

The ECB assumed preferred creditor status in Greece's debt restructuring earlier this year, leaving private investors to suffer a writedown in the value of their Greek sovereign bond holdings while the paper it held was untouched.

In another potential sop to the Bundesbank, Draghi said all bond purchases would be "sterilized" by taking in an equivalent amount in deposits from banks to avoid any risk of inflation.

The ECB's insistence on countries agreeing to strict conditions before it buys their bonds fed doubts about whether Spain would seek help, and led to disappointment with the new ECB bond-buying programme among some investors.

Draghi said bond buys would be tied to "strict and effective conditionality" and focused on debt maturities up to 3 years.

"The involvement of the IMF shall be sought also for the design of country-specific conditionality and the monitoring of such programs," he said, adding that now it was up to the governments of the euro zone to act.

International Monetary Fund chief Christine Lagarde welcomed the new ECB bond-buying programme and said the global lender was ready to cooperate "within our frameworks".

Spanish Prime Minister Mariano Rajoy and German Chancellor Angela Merkel said they did not discuss conditions for aid for Spain, despite expectations Rajoy would seek Germany's support for a bailout in a bilateral meeting in Madrid on Thursday.

"A lot depends on the country asking for help through the ESM, and Spain doesn't seem to be ready," said Francois Savary, chief investment officer at Reyl in Geneva. "It means that a lot remains in the hands of politicians."

(Writing by Mike Peacock and Paul Carrel; Editing by Paul Taylor)

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Comments (16)
dareconomics wrote:
The latest plan that will save everything uses the euphemism for Outright Monetary Program. See, by using the word “monetary” you make it really a plan to transmit monetary policy rather than the financing of governments prohibited by the ECB’s charter in Article 123. The dishonesty does not stop there.

Central planning is running amok in the Eurozone:

European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond- purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.

Interest rates have diverged in Europe because the risk of lending within each country has diverged. Draghi says that the program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro.” One man’s severe distortions are another man’s market forces.

Spain is in the midst of a severe economic depression, and Italy is in a recession. Due to these economic conditions, loans to companies within their borders are more risky and deserve a higher interest rate. When a central bank artificially lowers the interest rate by fiat, it does not lead to more lending as we have learned since 2008 (and since 1994 in Japan).

Banks are not getting compensated for the risk that they are undertaking due to the controlled rate, so they choose not to lend to the private sector; however, they have no problem using their capital to buy sovereign debt in this rigged game. With the Draghi put, there is virtually no risk in carrying short-term Spanish or Italian bonds.

This program will not solve the problems of an ill-fitting currency union; it will merely keep it afloat longer. Banks will continue to purchase sovereign bonds and will actually decrease their lending to the private sector to do so. One of the unintended consequences to this program will be reduced economic growth in the PIIGS.

Another problem with this plan is the seniority issues. For some reason, the mainstream media glides over this issue. Recall that when Greece needed a bailout, the ECB was not involved in the write-down. Nothing in the bond covenants, the ECB charter or any other European rule or regulation gave the ECB senior status.

Yet, there it was getting 100% of its money when the bailout was crammed down on the private sector. Now, the ECB is saying, “Don’t worry. We won’t act illegally again,” and this claim is merely repeated without any scrutiny in articles I read in the NYT, WSJ, Reuters and Bloomberg.

Why is the ECB being treated with kid gloves when it is in the midst of such a blatant power grab? The new program requires countries to apply for an official bailout with “conditions.”

Ask Greece about what conditions mean. Spain and Italy will be forced to sign memorandums of understanding pledging to enact certain reforms; I add that these reforms would never fly in Germany’s over-regulated economy.

These countries will also be subject to periodic inspections. The ECB board will be able to cut off funding if it feels that the conditions are not being honored. Applying for a bailout will be tantamount to a regime change. The people may stand for budget cutbacks, but I do not think that they wish to be humiliated at the hands of their so-called allies.

This plan must be placed in the context of the ongoing Eurozone recession. Once again, the mainstream media falls flat on its face and repeats the rosy forecasts of the ECB, which calls for economic growth next year while conditions continue to worsen.

Economic red flags are no longer confined to the PIIGS; the northern core countries have witnessed steadily deteriorating economic conditions and look poised to enter a recession. Remember, the PIIGS are Germany’s largest trading partners, and they are importing less due to the depression/recession.

No matter how the Eurocrisis is spun, the economic fundamentals point to a continuing malaise. Two years ago, serious reform combined with some short-term assistance by the ECB could have prevented the endgame. Now, I believe that a Eurozone breakup is inevitable, but the timing is indefinite.

dareconomics.wordpress.com

Sep 06, 2012 10:52am EDT  --  Report as abuse
mikemm wrote:
This soounds a lot like the quantitive easing that the Fed has been doing to put money into the US economy, except instead of lending to banks at super low rates, it pays off some debts, but the effect is similar.
This actually could work along with the things that China is doing to pump up their infrastructure and what the U.S. has been doing all along. It’s a global issue, so independently each scheme may not work as well as it could since they are not in a vaccuum, but together it could help turn things around on a big scale.

Sep 06, 2012 2:30pm EDT  --  Report as abuse
JLWR wrote:
This is global corrupt insanity.

Sep 06, 2012 3:41pm EDT  --  Report as abuse
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