Can Super Mario save the eurozone?
Now's the time for the European Central Bank president to back up his rhetoric with action
Thursday 02 August 2012
"Believe me, it will be enough." European Central Bank president "Super" Mario Draghi's recent promises of shock and awe tactics to defend the eurozone have rallied the spirits of investors worldwide ahead of today's Frankfurt meeting of the central bank's governing council.
But he has to make good on his rhetoric last week – and heaven help him if he doesn't deliver. Traders have piled back into shares in the past seven days. If Mr Draghi fails to satisfy fevered expectations, the peripheral stragglers could face a painful new debt sell-off.
Unlike the endless summitry of Europe's political leaders, the European Central Bank (ECB) can occasionally produce the goods.
A year ago, before Mr Draghi took the reins, the ECB under Jean-Claude Trichet spent more €200bn (£156bn) through its Securities Market Programme (SMP), buying up eurozone debt to quell a market panic which threatened to sink Spain and Italy.
Mr Draghi himself is capable of spectacular interventions. His move to pump €1trn in cheap, three-year loans into the European banking system last year via so-called long-term refinancing operations drove down the dangerously high borrowing costs of Spain and Italy, as banks swapped the cheap funding into sovereign debt yielding better returns.
Analysts suggest more options are open to the ECB following the Brussels summit at the end of June. This paved the way for the ECB to be able to intervene directly in bond markets via its current bailout pot, the European Financial Stability Facility (EFSF), and its successor, the European Stability Mechanism (ESM), which has yet to come into legal force.
Experts say we may see an announcement from the ECB to buy up bonds on behalf of the EFSF, as well as a potential reactivation of the SMP bond-buying programme. The sticking point is, under the current arrangements, a country has to make a direct request for help before the EFSF can be used to buy its debt.
Carsten Brzeski, an economist at the Dutch bank ING, said: "My view is the ECB will be restarting bond purchases. My best guess is they start to buy bonds as an agent of the EFSF, although normally this would require a special request. Acting as an agent is more attractive because the ECB does not breach its mandate. We may see the SMP used as well because the EFSF's current lending capacity after previous bailouts is only around €120bn."
Cranking up the SMP again is also likely to create political tensions as it is widely seen as the central bank printing money to pay off a country's debt, even though the ECB sucks deposits out of the system to "sterilise" the purchases. BGC Partners' analyst Michael Ingram said: "Part of the problem is that the SMP has always been presented as 'limited and temporary'. To cow markets and sustainably lower yields in Spain and Italy, this needs to be replaced by 'unlimited' and 'permanent'."
Given that the central bank cut rates to 0.75 per cent last month, another cut is unlikely today. Further long-term loan operations are possible, but also seen as doubtful, because Europe's banking system is now awash with liquidity. Easing collateral requirements for banks to make it easier for them to borrow from the ECB would also be welcome, but none of these represents the blunderbuss desired by the market.
What eurozone investors really want is a "magic bullet" solution. Top of the list is the granting of a banking licence for the €500bn ESM, allowing it to draw on the unlimited firepower of the ECB to support sovereign debt when it comes into force and create what the eurozone lacks: a lender of last resort. Again, Germany – on the hook for the ECB's liabilities – is likely to oppose such a move.
Another nuclear option would be full-scale quantitative easing (QE) along the lines carried out by other central banks, although this runs against the ECB's mandate which prevents debt financing of eurozone governments. Altering this would require a treaty change.
Mr Diebel said: "If Mr Draghi really wants to shore up the eurozone system he could do more QE. It's not allowed under their mandate, but that mandate also allows them to basically do whatever they wants to protect the eurozone. It's a red line for them, but they've crossed red lines before."
Whatever the ECB does, experts agree its powers to solve the crisis are limited as troubled nations which binged on the eurozone meal-ticket during the good years struggle to enact reforms.
The best it can do is fill in the gaps while politicians edge towards the closer political and fiscal integration needed to quell the crisis permanently.
For now, it's over to you, Mario.
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