The European Central Bank
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Draghi’s plan
A lot of things have to go right for the ECB’s bond-buying plan to succeed
Aug 11th 2012
THERE is a common pattern to each stage of the euro crisis. First, there is panic in the markets.
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Then either the politicians or the European Central Bank (ECB) respond with commitments or actions that quell nerves. And each time the periods of calm become shorter.
On August 2nd Mario Draghi, the ECB’s president, made another attempt to soothe markets by outlining a new framework for buying bonds in the secondary market. Investors were initially unimpressed: they had hoped for actions, not plans. But the mood since then has been cheerier, as appreciation of his ingenuity has deepened.
The ECB has bought bonds before—to bring down Spanish and Italian bond yields last summer, for example. But future purchases will differ from previous ones. They will be directed at shorter-duration bonds rather than those with longer maturities. And they will be made only if countries needing support first apply for help to the euro area’s rescue funds. Unlike the ECB, these funds are allowed to buy bonds when they are first issued, but they are unlocked only if the countries in question comply with strict terms.
The ECB plan makes the most of the bail-out funds’ limited resources—their new lending capacity is €500 billion ($620 billion)—by getting covering fire from the ECB in secondary markets. Central-bank purchases will not alleviate the pressure on backsliding governments if countries have to meet specific conditions. Intervening at shorter maturities is another way of maintaining pressure: countries prefer to borrow for longer to avoid having to roll over debt too often.
Mr Draghi also promises to tackle one of the big worries that investors have. Ever since the ECB’s decision to exempt itself from the Greek sovereign-debt restructuring earlier this year, bondholders have feared that more central-bank purchases would simply push them down the creditors’ ladder. These concerns about seniority will be addressed, says the ECB.
Even if they get that right, there is an awful lot that could derail the plan. For one thing, nothing is likely to happen until September 12th when the German constitutional court is due to rule on the legality of the euro area’s permanent rescue fund. That date also matters because it is when Dutch voters go to the polls. If the Dutch follow the Finns in voting in large numbers for an anti-euro party, that would either increase resistance among creditor countries to using the bail-out funds, or mean even tougher conditions for debtor countries.
A reluctance in both Italy and Spain to sign up for a bail-out is already an obstacle. For if there is rescue fatigue in northern Europe, there is reform fatigue in southern Europe, with electorates increasingly hostile to austerity programmes that appear to be leading to deeper recessions.
What’s more, Mr Draghi’s plan has not won over Jens Weidmann, the president of Germany’s Bundesbank. Mr Draghi knows that Germans revere their central bank; he also knows that it is Germany that underwrites the euro. That could mean that any bond purchases made by the ECB will be smaller than the markets are expecting. Mr Draghi is proving to be as adroit a diplomat and politician as he is a central banker. But since he must offer both succour to debtor countries and reassurance to creditors, he has worryingly little room for manoeuvre.
.
Then either the politicians or the European Central Bank (ECB) respond with commitments or actions that quell nerves. And each time the periods of calm become shorter.
On August 2nd Mario Draghi, the ECB’s president, made another attempt to soothe markets by outlining a new framework for buying bonds in the secondary market. Investors were initially unimpressed: they had hoped for actions, not plans. But the mood since then has been cheerier, as appreciation of his ingenuity has deepened.
The ECB has bought bonds before—to bring down Spanish and Italian bond yields last summer, for example. But future purchases will differ from previous ones. They will be directed at shorter-duration bonds rather than those with longer maturities. And they will be made only if countries needing support first apply for help to the euro area’s rescue funds. Unlike the ECB, these funds are allowed to buy bonds when they are first issued, but they are unlocked only if the countries in question comply with strict terms.
The ECB plan makes the most of the bail-out funds’ limited resources—their new lending capacity is €500 billion ($620 billion)—by getting covering fire from the ECB in secondary markets. Central-bank purchases will not alleviate the pressure on backsliding governments if countries have to meet specific conditions. Intervening at shorter maturities is another way of maintaining pressure: countries prefer to borrow for longer to avoid having to roll over debt too often.
Mr Draghi also promises to tackle one of the big worries that investors have. Ever since the ECB’s decision to exempt itself from the Greek sovereign-debt restructuring earlier this year, bondholders have feared that more central-bank purchases would simply push them down the creditors’ ladder. These concerns about seniority will be addressed, says the ECB.
Even if they get that right, there is an awful lot that could derail the plan. For one thing, nothing is likely to happen until September 12th when the German constitutional court is due to rule on the legality of the euro area’s permanent rescue fund. That date also matters because it is when Dutch voters go to the polls. If the Dutch follow the Finns in voting in large numbers for an anti-euro party, that would either increase resistance among creditor countries to using the bail-out funds, or mean even tougher conditions for debtor countries.
A reluctance in both Italy and Spain to sign up for a bail-out is already an obstacle. For if there is rescue fatigue in northern Europe, there is reform fatigue in southern Europe, with electorates increasingly hostile to austerity programmes that appear to be leading to deeper recessions.
What’s more, Mr Draghi’s plan has not won over Jens Weidmann, the president of Germany’s Bundesbank. Mr Draghi knows that Germans revere their central bank; he also knows that it is Germany that underwrites the euro. That could mean that any bond purchases made by the ECB will be smaller than the markets are expecting. Mr Draghi is proving to be as adroit a diplomat and politician as he is a central banker. But since he must offer both succour to debtor countries and reassurance to creditors, he has worryingly little room for manoeuvre.
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