Mario Draghi might not be too worried about disappointing investors this week.
As markets look for the European Central Bank president to unveil details of his bond-purchase programme on Thursday, Italy and Spain are showing little willingness to request aid from Europe’s bailout fund - a pre-condition for the ECB to start buying their debt. A jump in bond yields may remind governments that they need to act first.
“The market is expecting a lot from the ECB,” Gustavo Reis, an economist at Bank of America Merrill Lynch, wrote in a note to clients. “However, we look for little clarification on the bond-buying programme. The likely market disappointment should intensify the pressure on Spain.”
Draghi’s plan hinges on governments asking the bailout fund to buy their bonds on the primary market, which would require them to sign up to strict conditions, before the ECB intervenes on the secondary market. While Spanish Prime Minister Mariano Rajoy and Italian Premier Mario Monti are heaping pressure on the ECB to act to lower their borrowing costs, they’re resisting making an application to the bailout fund for aid.
“Draghi’s announcement of intervention shows the robust will of the ECB to solve the problem,” Rajoy told Spain’s ABC, Germany’s Bild am Sonntag, France’s Le Journal du Dimanche and Italy’s Corriere della Sera in a joint interview published over the weekend. “I will await the results of the ECB and then make a decision that’s good for Spain and for the euro.”
The euro, which is down 12 per cent against the dollar in the past year, rose 0.03 per cent to $1.2576 on Monday morning.
Monti said in an interview with Il Sole 24 Ore, published on August 29, that the Italian government’s austerity measures are starting to offset market concerns and the country doesn’t need to tap European rescue funds at the moment.
Europe’s woes were center stage at the weekend meeting of central bankers and economists in Jackson Hole, Wyoming, with Federal Reserve Chairman Ben S. Bernanke among those identifying them as a threat to economic growth and urging that they be fixed.
“Some recent policy proposals in Europe have been quite constructive, in my view, and I urge our European colleagues to press ahead with policy initiatives to resolve the crisis,” Bernanke said.
In addition to governments dragging their heels, tensions between the ECB and Germany’s Bundesbank are growing. Bundesbank President Jens Weidmann, who opposes ECB purchases of government bonds, has considered quitting over Draghi’s plan, Bild newspaper reported on August 31.
Weidmann, who traveled to Jackson Hole while Draghi remained in Frankfurt to assemble the bond plan, said he “won’t comment on speculations” when asked about the report.
Italian and Spanish bond yields have receded since Draghi promised on July 26 to do whatever is needed to preserve the euro. While Spain’s two-year rate has dropped to 3.66 percent from 6.65 percent on July 24, it compares with minus 0.03 percent in Germany. Spain’s 10-year rate rose to 6.90 percent this morning compared with Germany’s 1.33 percent.
“A currency union can’t function if some countries are financing themselves at negative interest rates, while others have to face unbearably high yields,” Rajoy said in the interview. “Draghi has made clear that, more than anything else, doubt over the irreversibility of the euro is responsible for this dangerous yield divergence.”
Draghi said on August 2 that the ECB is working on a bond-purchase program to lower yields that policy makers will decide on at this month’s meeting.
No single option has emerged as preeminent and ECB council members will have only about 24 hours to digest Draghi’s proposal before they start debating it, three central bank officials said on August 31.
The ECB’s Executive Board will send a list of options to the 17 governors tomorrow, a day before the Governing Council convenes in Frankfurt, the officials said on condition of anonymity. The meeting ends on September 6, after which Draghi holds his regular press conference. German Chancellor Angela Merkel travels to Madrid for talks with Rajoy the same day.
“The ECB should act and the sooner it does the better,” said Angel Gurria, head of the Organization for Economic Cooperation and Development. “The ECB needs to tell markets it is ready to act. The whole European system is at stake. The ECB is the big bazooka.”
Options under consideration by the ECB include sovereign bond yield caps and targets on spreads over German bunds, the three central bank officials said. One added that there has also been discussion about making purchases in a range of asset classes and not just government bonds. An ECB spokesman declined to comment.
The lack of a clear preference, the complexity of the issue and the shortage of time increase the risk that Draghi won’t present a detailed plan this week, according to economists at Commerzbank AG and JPMorgan Chase & Co.
The ECB may also choose to hold back some details of the plan until the German Constitutional Court rules on the legality of Europe’s permanent bailout fund on September 12, two of the officials said.
“Draghi will be vague, and he should be,” said Erik Nielsen, global chief economist at UniCredit Bank AG in London. “He’ll reiterate the conditionality aspect, that whatever they’ll do will be ‘enough’,” and that “the objective of such interventions, if they happen, will be to prevent speculation of a euro-zone break-up.”
The ECB will publish new economic forecasts on September 6 that council member Ewald Nowotny has said are likely to revise down the outlook for growth.
Economists are divided on whether the ECB will cut interest rates further. While the median estimate in a Bloomberg News survey of 57 economists is for a 25 basis-point reduction in the benchmark rate to a new record low of 0.5 per cent, 25 predict no change.
The ECB shouldn’t rush fresh anti-crisis measures until governments demonstrate they’re willing to act as well to quell the turmoil, former ECB council member Athanasios Orphanides said in Jackson Hole.
“What is crucial to see is how the governments are progressing on what they need to do,” Orphanides said in a Bloomberg Television interview on September 1. “It would not be a good idea for the ECB to rush into things without everything falling into place.”
Draghi has an “opportunity” to hold back details of the ECB’s bond program, said Ed Lalanne, a strategist at Macro Risk Advisors in New York. “I don’t think there’s going to be a full plan.”
