European Central Bank President Jean-Claude Trichet is the buyer of only resort as the euro area’s bond market melts down.
Just six months after he threw out his rule book to prevent Greece’s debt crisis from splintering the euro area, the 67-year old Frenchman may again be the only policy maker able to prevent the collapse in Irish and Portuguese bonds from spreading. That may require him to ignore opposition from Bundesbank President Axel Weber to the ECB’s bond-buying program and expand purchases of sovereign assets, according to Citigroup Inc. and Royal Bank of Scotland Group Plc.
The pressure on the Frankfurt-based ECB reflects its status as the only institution in the 27-nation European Union able to act fast enough to placate bondholders. The premium investors charge to hold Irish and Portuguese debt over German bunds reached records yesterday and the euro today fell to a six-week low against the dollar.
“The ECB’s lack of action is puzzling to say the least and begs the question as to whether it’s fulfilling its financial-stability mandate,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland in London. “The more the ECB waits, the bigger the purchase program will have to be.”
After reporting no settled transactions for three weeks, the ECB last week completed 711 million euros ($973 million) of purchases. Traders familiar with the transactions said it acted again this week by buying Irish assets under an emergency program set up to support the euro during the Greek rescue.
Scaring investors away from the bonds of Europe’s so-called peripheral nations is doubt over their ability to finance themselves and cut budget deficits fast enough.
Concern that those countries may end up restructuring their debt sent Irish bonds lower for 13 straight days, pushing the yield on 10-year debt to 8.9 percent yesterday from 6.9 percent at the end of October. The bonds snapped that decline today, with the yield falling 11 basis points to 8.8 percent.
When Greece faced a market rout in May, the ECB agreed to buy government bonds for the first time and European governments created a fund to provide cash to countries in need in return for them accepting stringent conditions.
With Greece, Ireland and Portugal “now having virtually lost access to capital markets,” Cailloux said the ECB must “extend dramatically” its bond purchases. He called on it to buy Spanish assets to limit contagion and spend an additional 100 billion euros by the beginning of next year. So far, the ECB has spent a total of 64 billion euros.
Forced to Act
“The ECB is being forced to deal with damage caused by others,” said Juergen Michels, chief euro-area economist at Citgroup in London. “Trichet has been clear he wants to have the market functioning and so they may have to consider doing more.”
One potential obstacle is Weber, a contender to replace Trichet as ECB president next year, who said last month that the central bank should terminate its purchase program.
“Given the controversy surrounding the securities markets program, the ECB is unlikely to step up its purchases to such an extent that market pressure abates,” said David Mackie, chief European economist at JPMorgan Chase & Co.
Weber is not the only German publicly disagreeing with Trichet. Chancellor Angela Merkel has quarreled with the central bank chief, whose tenure runs out on Oct. 31, 2011, over the terms of a permanent rescue facility now being debated by the European Union.
Sharing the Cost
Trichet says Merkel’s demand that bondholders be forced to share the cost of a future bailout risks undermining investor confidence. It was Merkel’s push for burden-sharing at a European Union summit last month that triggered this month’s sell-off, according to Mackie.
At a Nov. 4 press conference, Trichet contrasted Merkel’s approach with the International Monetary Fund’s assumption that aid recipients will respect debts to private creditors.
“The IMF does not make the ex-ante working assumption that the normal refinancing by markets -- by investors and savers -- is interrupted,” Trichet said. “It can be, but it is not the ex-ante normal assumption.”
European finance ministers today clarified their plans by saying in a statement that any new system for handling future crises would have “no impact whatsoever” on outstanding debt and may include a range of ways for investors to share the burden.
The statement was released in Seoul where a summit of Group of 20 leaders discussed Ireland’s woes and Merkel told reporters that “preparations are in place” for any aid request.
Trichet may ultimately lobby Ireland and Portugal to tap the EU rescue fund for fear volatile markets will derail the ECB’s plan to keep withdrawing liquidity, or even impinge on its ability to set monetary policy for 16 nations, said James Nixon, co-chief European economist at Societe Generale SA in London.
ECB Executive Board member Juergen Stark yesterday said the central bank intends to proceed with its exit strategy and its bond-purchase program is “temporary.”
“It is only a matter of time before the ECB is privately advising Portugal and Ireland to accept a bailout,” said Nixon, a former ECB forecaster. “The alternative appears to be either an interest rate that is too low for Germany or an appreciation of the euro that will condemn the euro’s peripheral economy to a long, slow death.”
While the Irish government says it’s fully funded through the middle of next year, economists including Julian Callow of Barclays Capital still identify it as the most likely to seek EU support, although it may try to wait until after the Dec. 7 announcement of its 2011 budget in the hope that measures to reduce the deficit by 6 billion euros will placate markets.
The question then is whether use of the EU stabilization fund is enough to end the crisis, as Goldman Sachs Group Inc. chief interest-rate strategist Francesco Garzarelli says, or if investors will just turn their sights on another economy, as predicted by Cailloux.
“The key message is we’re rapidly reaching a T-junction and we can’t keep going in a straight line,” Callow, Barclays’ chief European economist, said of Ireland. “The current situation is flatly unsustainable.”