European Central Bank President Mario Draghi said policy makers will do whatever is needed to preserve the euro, suggesting they may intervene in bond markets as surging yields in Spain and Italy threaten the existence of the 17-nation currency bloc.
“To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate,” Draghi said in a speech at the Global Investment Conference in London today. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” he said, adding: “believe me, it will be enough.”
Financial markets surged on speculation the ECB will act to lower Spanish borrowing costs after yields on the nation’s bonds rose to levels that prompted bailouts for Greece, Portugal and Ireland. The ECB reluctantly started buying Spanish and Italian debt in August last year as part of its bond purchase program. The buying had little lasting effect and the ECB suspended the program in March.
“His comments certainly suggest that ECB purchases of Spanish and Italian bonds are back on the table for discussion,” said Chris Scicluna, head of economic research at Daiwa Capital Markets Europe. “But -- just like last summer -- we would expect any new ECB bond purchases to be temporary and limited until other policies are put in place.”
Spanish yields slumped after Draghi’s remarks, with the rate on the 10-year bond dropping as much as 39 basis points to 6.91 percent. It touched a record 7.69 percent earlier this week. The euro jumped and stocks rose. The single currency climbed as high as $1.2318 after trading at $1.2118 before Draghi spoke. The Stoxx Europe 600 Index gained 2 percent.
The euro may have been buoyed by traders cutting bets on the shared currency falling against the dollar, or so-called short positions. Last week futures traders increased net bets the euro would fall against the greenback to 167,249 contracts, according to the Commodity Futures Trading Commission data.
“There is finally light at the end of the tunnel,” said Chris Rupkey, Chief Financial Economist at Bank of Tokyo-Mitsubishi UFJ Ltd in New York. “When the ECB is done there won’t be a short against the euro left on the planet.”
Other economists said it’s unlikely that the ECB will take large-scale action soon, pointing to Europe’s two bailout funds.
ESM Banking License?
“The ECB wants to see government money used first,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. “If that doesn’t work, they will put at stake ECB money.”
ECB Governing Council member Ewald Nowotny yesterday pushed up the euro and stock markets after saying in an interview that there are arguments in favor of giving Europe’s permanent bailout fund, the European Stability Mechanism, a banking license. That would enable it to refinance with the ECB, boosting its firepower.
Draghi has rejected that proposal in the past and didn’t refer to it today. Instead, he clearly signaled that ECB bond purchases are back on the agenda by referring specifically to the disruption of policy transmission on markets, said Nick Kounis, head of macro research at ABN Amro in Amsterdam.
“The ECB has always argued that the rationale behind its Securities Markets Program is to improve the functioning of its monetary policy, so there is little doubt that this is the tool he is referring to,” Kounis said.
After buying around 220 billion euros ($270 billion) of government debt, the ECB shelved its purchase program amid mounting resistance from some of its policy makers, particularly those from Germany.
Draghi has swollen market expectations before.
On Dec. 1 last year, he appeared to suggest to the European Parliament that the ECB would ramp up its government bond purchases if European leaders agreed on the then-novel idea of a fiscal compact.
Italy’s 10-year bond yields fell 37 basis points after those comments, only to rise 44 basis points a week later when Draghi downplayed the speculation. The ECB subsequently implemented two three-year loan programs that pumped more than 1 trillion euros into the financial system, helping to ward off a credit crunch.
Draghi said today that markets have underestimated the progress that’s been made in the euro area and that the monetary union is “irreversible.” Leaders have this year inked agreements that aim to push the single currency toward tighter joint budgetary surveillance and a so-called banking union.
“The progress in undertaking deficit control, structural reforms has been remarkable,” Draghi said. “They’ll have to continue doing so, of course, but the pace has been set.”