The European Central Bank is eager for Europe’s rescue fund to take responsibility for buying government bonds. Germany, though, may resist the switch.
“The ECB has always been uncomfortable with the purchases and it really wants out now,” said James Nixon, a former ECB forecaster who now works as co-chief European economist at Societe Generale in London. “It wants to go back to the day job of keeping a lid on inflation, and the program is starting to interfere with its monetary policy operations.”
ECB President Jean-Claude Trichet supports the European Financial Stability Facility taking on the task of capping yields. The central bank has spent 76.5 billion euros ($106 billion) buying the debt of Europe’s most-distressed nations. The EFSF, though, lacks the legal authority to purchase debt, according to a German government official who briefed reporters yesterday ahead of a Feb. 4 summit meeting.
Central bankers are pushing governments to take more responsibility for solving Europe’s debt crisis, seeking to scale back emergency measures that risk stoking inflation. Germany wants to make additional bailout efforts conditional on stricter control of countries’ finances, according to four officials involved in bailout talks who declined to be identified because the deliberations are private.
“Germany, as Europe’s paymaster, can use the EFSF bond purchases as a bargaining chip to put pressure on the periphery countries to get their house in order,” said Nicolas Doisy, a former French Treasury official who now works at CA Chevreux in Paris. Germany “can twist Spain’s or Portugal’s arm more than the ECB ever could, because you’d have governments talking to governments and that will also help drive down spreads.”
Europe’s leaders are debating how to expand the 440 billion-euro rescue fund. Greek Finance Minister George Papaconstantinou said yesterday he’s confident of reaching a “comprehensive” agreement next month. “The current market situation is one of expectations,” Papaconstantinou said. “It would be a big mistake to conclude an agreement that falls short of these expectations.”
In the past three weeks, four ECB policy makers and private sector executives including Deutsche Bank AG’s Chief Executive Officer Josef Ackerman have backed the mooted EFSF bond-purchase plan. French Finance Minister Christine Lagarde said the decision is “better left to finance ministers than bankers and advisers.”
“The list of demands on what the EFSF should do is getting longer and longer, and it may simply not be big enough to facilitate all those,” said Juergen Michels, chief euro-area economist at Citigroup Inc in London. “Let’s not forget that the original remit was to make the fund bigger so it could bail out Spain if needed. While the ECB demands may be valid, the fund may not be big enough.”
Bonds have rallied this week on investor optimism that the aid package will expand by enough to halt the debt crisis. Spain’s 10-year yield has declined to about 5.07 percent from 5.45 percent, while Portuguese yields have dropped more than 20 basis points to 6.82 percent. The premium investors demand to own Greek debt rather than German bunds has dropped to a three-month low of about 760.
The ECB started buying government bonds in May, an unprecedented move that drew criticism from council members Axel Weber and Juergen Stark, who said supporting the market for too long could fuel price increases and let profligate nations off the hook.
To stop its purchases boosting money supply and stoking inflation, the ECB each week drains the liquidity created by offering banks seven-day term deposits. This week, it failed to fully neutralize the liquidity created by its bond purchases for the third time since the program began.
Last month, Trichet stepped up his inflation-fighting rhetoric after December inflation unexpectedly exceeded the bank’s 2 percent limit for the first time in more than two years. It accelerated to 2.4 percent in January. He may reiterate calls for the EFSF to buy bonds at a press conference today in Frankfurt following the monthly policy meeting.
Central bank funding is becoming “more sharply skewed toward a handful of addicted banks” which can’t obtain money-market funding, said Nixon at SocGen. The ECB’s sterilization over the past two weeks left “the money markets short of funds” Nixon said, pushing up overnight borrowing rates to 1.31 percent on Feb. 1, the highest since June 2009.
Shifting the source of bond purchases may not underpin the fixed-income market. The buybacks haven’t “reined in spreads to any sufficient degree,” said Christoph Rieger, head of fixed income strategy at Commerzbank AG in Frankfurt. “The market doesn’t really gain that much, since the EFSF has to go and raise the funds while the ECB can use central bank money.”