ECB President Draghi yesterday praised the impact of the so-called OMT program in lowering borrowing costs, while playing down the prospect of further ECB rate cuts. “Market confidence has visibly improved on the back of our decisions as regards Outright Monetary Transactions,” he said. The announcement “by itself produced an easing of financial-market conditions.”
The OMT, unveiled on Sept. 6 in response to the threat of a euro breakup, aims to restore transmission of ECB rates by purchasing the bonds of countries like Spain if they apply for a European Union bailout and agree to conditions. While no country has yet done that, the mere threat of unlimited ECB intervention has reduced bond yields in troubled euro-area nations, assuming the job of the central bank’s traditional policy instruments as the economy lurches toward recession.
“The OMT’s signalling effect has a stronger easing effect than any rate cut or liquidity operation could currently have,” said Christian Schulz, senior economist at Berenberg Bank in London. The OMT’s “aim is to remove the tail risk of euro-zone break up. But besides reducing tail risks, the OMT also supports the economy.”
Draghi said the OMT announcement has led to “a series of improvements” on financial markets.
“There has been a return of flows from the rest of the world, in particularly U.S. money-market funds,” he said. “Another positive sign is that there has been some limited bond placement by euro-area institutions. There have been a few issuances by Ireland and Portugal.”
Draghi gave no indication of an imminent cut in the ECB’s benchmark rate, which it left at a record low of 0.75 percent yesterday, even as he acknowledged the central bank is likely to lower its economic forecasts next month. A rate reduction may involve the complication of taking the deposit rate, currently at zero, into negative territory.
“Draghi several times stressed that the announced OMT stabilized the currency union and thus led to a more expansionary policy because very low key interest rates can now better work through to businesses and consumers,” he said. “This supports our main scenario that the ECB is likely to keep rates stable in the months to come.”
The irony is that the impact of the OMT announcement has reduced pressure on Spain to seek help and trigger ECB interventions.
Spanish Prime Minister Mariano Rajoy said on Nov. 6 he needs to know how much the ECB would push down Spain’s borrowing costs before his government asks for help and signs up to the conditions attached. Bond yields have already dropped and there’s no point seeking a bailout if they don’t fall any further, he told Cope Radio.
“It’s entirely up to Spain and the Spanish government to take the decision,” Draghi said. “The ECB can’t give any assurances ex ante. The Governing Council will take the decision in total independence. There isn’t any automatic quid pro quo.”
As Spain delays its decision and the euro-area economy worsens, the ECB could still be forced to deploy its conventional weapons.
Economic confidence in the 17-member euro area fell to a three-year low in October, adding to signs that the region is in recession after gross domestic product shrank 0.2 percent in the second quarter. Third-quarter GDP is due on Nov. 15.
“We have pencilled in an interest-rate cut in December,” said Howard Archer, chief European economist at IHS Global Insight in London. “However, it is very possible that the ECB could delay trimming interest rates until early 2013 due to concerns that the impact of a near-term cut could be diluted by the problems in monetary policy transmission channels.”
There are signs that financial markets could lose patience with Spain and drive up yields to a point that forces the government to seek outside help.
While Spain’s 10-year bond yield has dropped more than 200 basis points since Draghi declared he would do whatever is needed to preserve the euro on July 26, it climbed 16 basis points yesterday to 5.85 percent. By comparison, Germany’s 10- year bond yield is at 1.36 percent.
“We don’t expect the ECB to simply wait for the political decisions being taken,” said Elga Bartsch, chief European economist at Morgan Stanley & Co. International in London. “As a result, the council will have to go back to the drawing board and look at the instruments that it has at its discretionary disposal.”
Draghi conceded as much yesterday.
“We stand ready to act with the OMT once the prerequisites are in place,” he said. “But we also stand ready to act with the rest of standard normal monetary policy instruments.”
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