THE ECB DANGEROUS FLIRTATION / THE WALL STREET JOURNAL ( RECOMMENDED READING )

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MAY 10, 2010, 1:56 P.M. ET.

The ECB's Dangerous Flirtation .

By RICHARD BARLEY

So the market got its way after all. The European Central Bank's decision to sanction the purchase of government and private debt securities is potentially the most significant plank in the package of measures unveiled Monday to tackle the euro-zone crisis, not least because this remarkable U-turn risks enmeshing the ECB deeply in the realm of fiscal policy, compromising its credibility and independence. But the ECB's refusal to spell out the details of its program means the full financial implications are hard to judge.

The absence of these details is probably part of the policy, keeping market participants uncertain as to where, when and whether there will be an intervention, and thus possibly deterring short sales of securities. It may also reflect that, in some illiquid markets—Portugal, for instance, has just €97 billion ($123 billion) of benchmark government bonds outstanding—only small amounts of purchases may be necessary to cap yields and spur private buying. In this respect, the program may be like that under which the Bank of England bought corporate bonds in order to help boost liquidity, J.P. Morgan notes; purchases there amounted to just £1.4 billion ($2.1 billion). Monday's extraordinary rally in euro-zone peripheral bonds suggests the ECB has so far got a lot of bang for its buck.

Still, the ECB insists its planned bond purchases are different from the quantitative easing undertaken by the U.S. Federal Reserve and the BOE since they are aimed at improving financial stability rather than loosening monetary policy. Although the purchases will involve the expansion of the balance sheets of euro-zone members' central banks, President Jean-Claude Trichet said Monday the ECB would seek to minimize inflation risk by "sterilizing" its interventions—in other words, by draining excess cash from the system, possibly through the issue of term deposits.

Even so, the ECB's experiment with bond buying will increase the European monetary system's exposure to potential credit losses if the sovereign-debt crisis turns out to be one of solvency rather than liquidity. Meanwhile, the risk remains that the ECB will allow itself to be pushed again by the market into making the program too big or using it too frequently, at which point investors might simply use the ECB's bid to exit, rather than enter, the euro-zone government-bond markets. Once gone, they may be hard to lure back.

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