European Central Bank President Mario Draghi said the ECB may wade forcefully into bond markets in tandem with Europe’s rescue fund, stepping up its crisis response despite the reservations of Germany’s Bundesbank.
“The euro is irreversible,” Draghi said at a press conference in Frankfurt today after keeping the benchmark interest rate at 0.75 percent. Elevated bond yields “that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner,” he said. The ECB may therefore “undertake outright open market operations of a size adequate to reach its objective.”
The euro declined and Spanish bond yields rose on disappointment that Draghi didn’t signal imminent ECB action. While Draghi said the Bundesbank has reservations about ECB bond purchases, and the details of the plan still need to be hammered out, the proposal nevertheless signals a new chapter in the battle against the debt crisis. Draghi left open the question of whether the ECB would print new money by refraining from sterilizing asset purchases
“Although the ECB did not start to actually intervene in bond markets today, Draghi sent a strong message that the ECB will do all it takes,” said Holger Schmieding, chief economist at Berenberg Bank in London. “Of course, the ECB cannot and has not solved the euro crisis. But all in all, the chances have risen substantially that the worst of the current wave of the crisis could soon be over.”
Draghi said ECB bond purchases would be in the secondary market, focus on shorter-term maturities and address investors’ concerns about seniority. They would only be used to complement buying by the rescue fund in the primary market, to which strict conditionality is attached, he said. ECB officials are working on the plan and details will be fleshed out in coming weeks.
Unlike the ECB’s previous bond-buying program, which was shelved in March, Draghi said no decisions have been taken on whether new purchases would be sterilized. If they aren’t, the ECB would be entering similar territory to the Federal Reserve and Bank of England by pumping new money into the system without draining it elsewhere.
The euro initially climbed as much as 0.5 percent to $1.2405 after Draghi’s comments before falling to $1.2151 at 6:10 p.m. in Frankfurt. The yield on Spain’s two-year bond dropped 10 basis points to 4.8 percent, while those on longer-dated maturities rose. Italy’s 10-year yield surged 58 basis points to 6.32 percent.
No ‘Concrete Measures’
“The market reacted positively when Draghi said the ECB will address the seniority issue,” said Mohit Kumar, head of European fixed income strategy at Deutsche Bank AG, Germany’s biggest bank. “But then when details emerged, it suggested he is giving guidelines without giving concrete measures.”
Financial markets and politicians had ratcheted up pressure on the ECB to act after Draghi pledged on July 26 to do “whatever it takes” to preserve the euro. The Bundesbank reiterated the next day that it opposes further purchases of sovereign debt by the ECB, saying they blur the line between fiscal and monetary policy.
“It is clear and it is known that Mr Weidmann and the Bundesbank have their reservations about programs that buy bonds,” Draghi said, referring to the head of the German central bank.
He said governments must stand ready to activate the rescue fund in bond markets, which would require a country such as Spain to make a formal request for aid. While Spanish Prime Minister Mariano Rajoy today welcomed Draghi’s comments, he declined to say whether Spain will ask the bailout fund to buy its bonds.
The Fed yesterday pledged to take new policy steps as needed to promote stronger economic growth and employment. The Bank of England held its key rate at 0.5 percent and its bond-purchase target at 375 billion pounds ($586 billion).
Draghi said the ECB may introduce additional non-standard measures and that officials also discussed cutting interest rates further, raising the prospect they will ease policy as soon as next month.
“I’m convinced that there’s concerted action being prepared in the background,” said Stephan Rieke, an economist at BHF-Bank AG in Frankfurt. “But we’re all treading in the dark and Draghi isn’t much ahead either. He’s presented a target, given strong guidance, and now we’ll have to see.”