Time to steady the nerves: Mario's made his plans
With the credit rating of the eurozone at risk from Moody's, Europe's leaders want to know if the ECB head can live up to his promises
Wednesday 05 September 2012
Mario Draghi will be treading the finest of lines on Thursday when unveiling the European Central Bank's plan to shore up ailing government finances across the eurozone. Do little, and Mr Draghi is in danger of sending equity and bond markets into a fresh tailspin; promise too much, and the Germans will not write the cheque.
If "Super Mario" needed any reminder of how fine a line he is treading, it certainly came yesterday, when the ratings agency Moody's moved the whole eurozone's triple A credit rating on to a negative watch. Its reasoning? The key economies in the eurozone, such as France and Germany, are being dragged down by the eurozone crisis, while their governments are being exposed to more and more debt.
Despite Moody's downgrade threat, the recent news from the eurozone has been better, with equity markets moving upwards over the summer while crucial Italian and Spanish government bond yields go in the opposite direction, but this has all been dependent on Mr Draghi living up to his earlier promise that the ECB's plans "will be enough" to reassure markets that at last something is being done about the eurozone crisis.
Alan Clarke, an economist at Scotiabank, said: "Now is the time to see some meat on the bones. If Mr Draghi fails to unveil a coherent plan for dealing with the bonds of the likes of Spain and Italy, then all the good of recent times will be undone, which would be madness."
Markets seem to be of the same view. The minimum they are expecting is Mr Draghi to commit the ECB to buy the bonds of ailing eurozone countries, but unlike the last time the central bank went on such a spree, in 2011, there will be strings attached. For starters, the scheme is very likely to be limited to short-term debt – government bonds which mature in two or three years – as this will allow the ECB to get around claims that they are in effect funding national governments. The ECB is looking to bring a more precise weapon to bear – a scalpel rather than the scattergun of last year. It's hoped that by shoring up short-term debt, markets will be reassured that eurozone finances aren't going to go pop, which should help to reduce the cost of longer-term government borrowing, keeping the likes of Italy and Spain out of the danger zone.
"It's the size of the ECB's commitment to buy government bonds as well as the conditions attached that everyone will be watching," Philip Shaw from Investec said. "Make the conditions too strict and then the likes of Italy and Spain will not use the ECB's bond buying facility. Make them too loose and we may have a repeat of the past, when the ECB bought government bonds only for the national governments to go soft on their debt reduction plans," Mr Shaw added.
In advance of Mr Draghi's announcement, the yields on short-term Spanish and Italian bonds have slumped, as most anticipate these will be the main targets for the ECB bond buying scheme. If the scheme doesn't live up to these expectations, then it's likely that borrowing costs for the ailing eurozone members will rocket, perhaps to the levels seen in 2011, before the ECB's last major intervention. At that point the ECB would probably have to step into a panic situation, so action is better now rather than later.
As ever, though, the Germans have to be thrown into this mix. Europe's paymasters will only give the nod to the ECB's plans to buy the bonds of the likes of Italy and Spain at an EU leader's summit later this month if they feel that finally these governments won't use the ECB's intervention as a means to row back on austerity. But it seems that in Berlin there is at least an understanding that Mr Draghi must be allowed to get on with his limited rescue act.
Perhaps in need of a stiff drink or two, German Chancellor Angela Merkel told a meeting held in a packed beer tent in the town of Abensberg, near Munich, that after two years of political paralysis, now was the time for action. "It's not enough just to keep muddling through. These countries deserve our solidarity and that we root for them."
And the economic costs to Germany of doing nothing are mounting, with Scotiabank putting the cost of the eurozone crisis to its economy at about €50bn a year in lost output.
In an attempt to get their ducks in a row ahead of Mr Draghi's announcement, Ms Merkel welcomed the European president Herman Van Rompuy for talks yesterday, while the Italian premier, Mario Monti, laid out the red carpet for France's François Hollande.
Luca Jellinek, head of European interest-rate strategy at Credit Agricole, said there was now "broad agreement among these people. Many are realising that monetary policy is broken in Europe, badly broken."
Mr Draghi is capable of the spectacular. Late last year the ECB pumped €1 trillion into the European banking system to stave off a liquidity crisis, which had the handy knock-on effect of reducing government borrowing costs across the eurozone. This time around most analysts are expecting fewer fireworks from the ECB – with interest rates likely to remain on hold at 0.75 per cent – instead, just a coherent plan that will hold together would be nice. Mr Draghi's announcement, if it's what is expected, could eventually be seen as a staging post out of the eurozone crisis, but only if the Germans feel that the bad boys of the eurozone understand that this is not a "get out of jail free" card from austerity.
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