After 2 1/2 years of incremental crisis management and false starts, a bargain is beginning to emerge between Europe’s politicians and central bankers over how to calm bond markets and end the debt tumult that threatens the euro’s survival.
The European Central Bank sketched out its side of the deal yesterday, offering to buy Italy’s and Spain’s bonds on the market as long as the euro governments’ bailout fund makes purchases directly from the two countries’ treasuries and ties them to tough conditions.
ECB President Mario Draghi offered only a glimpse of the new strategy, with the actual interventions weeks or months away and a host of obstacles standing in the way before Europe can claim to be on a path out of the crisis that emerged in Greece in late 2009. Investors looking for a quicker fix pushed down the euro, European stocks and bonds of at-risk countries.
“All of the announcements, if transferred into actual activity, would be close to the big bazooka approach that the markets are looking for,” said Charles Diebel, head of market strategy at Lloyds Banking Group Plc in London. “Market disappointment is hardly surprising in this context but we may well find this lays the groundwork for the grand plan in coming weeks.”
The euro jumped as high as $1.2405 on the initial ECB announcement, falling back as Draghi’s caution that “it was not a decision, it was guidance” sank in. The 17-nation currency bought $1.2298 at 10:03 a.m. today Frankfurt time, up 0.3 percent.
The yield difference between 10-year Italian bonds and similar-maturity German bunds narrowed seven basis points to 502 basis points, after jumping by 54 basis points. Spain’s yield difference compared to bunds rose seven basis points to 600 basis points.
In the trading rooms, skeptics recalled the failure of European authorities to deliver on prior crisis-fighting pledges, whether by restricting the use of the original 440 billion-euro ($535 billion) rescue fund or forcing through a restructuring of Greece’s debt after promising not to.
“The big bazooka is Draghi’s implied promises, which have not been delivered upon,” said Marc Ostwald, a strategist at Monument Securities Ltd. in London. “Markets are saying this is all talk, there’s nothing concrete.”
What is different now is that the two countries with their backs against the wall, Italy and Spain, represent 28 percent of the $12 trillion economy and have new leaders that have forced through deficit-slashing measures over mounting domestic opposition.
“The ECB’s decision is important,” French President Francois Hollande told reporters in Paris. “It allows the ECB to intervene when it’s necessary.” German Chancellor Angela Merkel, who is on vacation, didn’t air any immediate qualms; on July 27, she and Hollande made a joint pledge “to do everything to safeguard” the euro.
Draghi’s offer to join forces with governments contrasted with the maneuvering in August 2011 by his predecessor, Jean-Claude Trichet. With Europe’s rescue fund not yet empowered to intervene on bond markets, Trichet ended up going solo in starting the purchases of Italian and Spanish debt.
Italy’s then-government, led by Silvio Berlusconi, chafed at the ECB’s insistence on budget cuts, and the central bank had no way of enforcing its writ. Opposition from the two Germans on the ECB’s policy council limited the size of the bond purchases and led to their suspension six months later.
Draghi is operating in a different political constellation. Berlusconi is gone, replaced by the non-partisan Mario Monti, now in the midst of enacting 26 billion euros of spending cuts. In Spain, Prime Minister Mariano Rajoy has delivered three rounds of austerity since taking office last December.
Moreover, Europe’s political establishment has courted the ECB by giving Draghi a lead role in fixing the birth defects of the monetary union that go back to the 1991 Maastricht Treaty. Along with European Union President Herman Van Rompuy, European Commission President Jose Barroso and Luxembourg Prime Minister Jean-Claude Juncker, the central banker is co-drafting proposals for a closer fiscal union and more integrated banking system.
Neither the Italian nor Spanish leader took up the ECB’s conditions yesterday. At a press conference in Madrid two hours after Draghi’s announcement, Monti and Rajoy shrugged off questions whether they would ask for a primary market bond-purchasing program by the rescue funds.
“I don’t know if the Italian government will ask for activation of this instrument,” Monti said. Rajoy declined to answer the question.
A bond-buying program would require Italy and Spain to make austerity and economic-reform commitments -- or potentially only restate the ones they’ve already made -- and submit to international monitoring. Spain has already gotten over the stigma of relying on outside help by tapping a 100 billion-euro program to shore up its banks.
Draghi’s pledge took the ECB further away from its roots as a politically autonomous central bank, modelled on Germany’s Bundesbank, with prime responsibility for containing inflation and only a lesser focus on the broader economy and the stability of the banking system.
The Bundesbank’s leader, Jens Weidmann, was alone on the ECB’s 23-member policy council in expressing “reservations,” Draghi told the press. For now, Weidmann stayed silent, contrasting with the objections to the ECB’s original bond-purchasing program that were immediately voiced by his predecessor, Axel Weber, in May 2010.
One reason Draghi had to buy time is that European governments won’t be able to act until at least mid-September, the earliest possible startup date for the planned 500 billion-euro permanent rescue fund, the European Stability Mechanism. It faces a German supreme court ruling on Sept. 12.
Until then, Europe’s only rescue vehicle is the European Financial Stability Facility, with as little as 148 billion euros left over after last month’s approval of Spanish bank aid.
“Whatever the short-term gut reaction of markets, the ECB announcement constitutes serious progress,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The chances have risen substantially that the worst of the current wave of euro crisis could soon be over.”