European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond-purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.
The program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at a press conference in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent. “Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”
Draghi has staked his credibility on the bond plan, which is the most ambitious yet in the central bank’s fight to wrest back control of rates in a fragmented economy and save the euro after nearly three years of turmoil. Now it’s up to governments in Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund and signing up to conditions.
“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial-market circumstances and risks to financial stability exist -- with strict and effective conditionality,” Draghi said. The ECB reserves the right to terminate bond purchases if governments don’t fulfil their part of the bargain, he added.
The euro fell as Draghi spoke before recovering to trade little changed and $1.2633 at 5:15 p.m. in Frankfurt. The yield on Spain’s two-year government bond dropped to 2.97 percent, a five-month low, while the rate on Italy’s two-year bond declined 13 basis points at 2.32 percent.
Germany’s Bundesbank was the sole objector to Draghi’s plan on the ECB’s 23-member Governing Council. Bundesbank President Jens Weidmann issued a statement after Draghi’s press conference saying the bond program is “tantamount to financing governments by printing banknotes” and may encourage them to postpone necessary reforms.
Draghi’s move pushes the ECB further into uncharted territory as central banks try to revive the world economy. Federal Reserve Chairman Ben S. Bernanke on Sept. 1 signaled he may soon deploy a new round of unconventional monetary policies.
“Over the years, global investors have learned that it does not pay to fight the Fed,” said Holger Schmieding, chief economist at Berenberg Bank in London. “Those betting on the demise of the euro may now have to realise that the ECB is as mighty as the Fed.”
The ECB’s program, called Outright Monetary Transactions, will target government bonds with maturities of one to three years, including longer-dated debt that has a residual maturity of that length, Draghi said. Purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral, and the ECB will not have seniority, he said.
“Draghi has delivered and buried any doubt that he would do what he promised, and this time it will be enough,” said Carsten Brzeski, senior economist at ING in Brussels. “The ball is now firmly in the courts of the governments. He’s thrown down the gauntlet to them.”
German Chancellor Angela Merkel, who met with her Spanish counterpart Mariano Rajoy in Madrid today, said the ECB is acting within its mandate to ensure monetary stability. Even so, measures that serve to stabilize the currency “cannot replace political action,” Merkel told reporters.
Rajoy said he needs time to analyze Draghi’s comments and “when I have anything new to tell you, I will say so.”
Draghi said the ECB alone will decide on how activate, run and suspend any bond buying. The International Monetary Fund will be asked to help design and monitor country-specific plans.
Purchases may also be considered for euro-area countries currently under bailout programs, such as Greece, Portugal and Ireland, when they regain bond-market access, Draghi said. The ECB will publish details of how much it spends on a weekly basis. Information on the average duration and the national breakdown of its new holdings will come every month.
The ECB has been at the forefront of fighting the debt crisis, which broke out in Greece in late 2009. Since then, fears about the future of the euro have ricocheted through the 17-nation bloc, pushing five countries into bailout requests and driving the economy to the brink of another recession.
The central bank today forecast a deeper economic contraction for 2012 than it did three months ago. Euro-area gross domestic product will drop 0.4 percent this year instead of 0.1 percent, it said.
In 2013, the economy will expand 0.5 percent rather than the 1 percent forecast in June. At the same time, the ECB raised its projection for inflation next year to 1.9 percent from 1.6 percent.