Jens Weidmann might not be as defeated as it seems.
While the European Central Bank pushed ahead with its bond-purchase plan over the Bundesbank president’s objections, the conditions attached are giving Spain second thoughts about applying for the program. Economists and central bank officials say those conditions were partly a response to Weidmann’s opposition, showing that even in his apparent isolation on the ECB council, he is still shaping policy.
Conditionality “was devised to appease the traditional Bundesbank allies” like the Netherlands, Finland, Belgium and Luxembourg, said former ECB chief economist Juergen Stark. “So Weidmann’s influence may still be working on a more subtle level.”
The result is the best of both worlds for the ECB, which has succeeded in driving down bond yields in Italy and Spain without having to spend a cent. The risk is that investors grow tired of waiting for Spain to act and start fretting that ECB intervention isn’t a foregone conclusion.
Draghi reiterated today that while the ECB stands “ready to undertake” bond purchases, “it’s entirely up to Spain and the Spanish government to take that decision.”
There is little doubt that Weidmann lost the argument over the ECB’s latest response to the sovereign debt crisis. He was the only one of the bank’s 22 Governing Council members to vote against Draghi’s unlimited bond-purchase plan, arguing it is tantamount to printing money to finance governments.
Yet the Bundesbank was actively involved in designing the specifics of the program and supported strong conditionality, said two central bank officials who spoke on condition of anonymity.
Weidmann’s concerns were “vital” to the design of the bond program, ECB chief economist Peter Praet told Germany’s Handelsblatt newspaper on Oct. 31. The ECB will only buy bonds if a country signs up to budget consolidation and structural reforms, he said.
“The Bundesbank isn’t the same dominant voice at the ECB that it was in the past, but to say that its influence has been completely pulverized is simply wrong,” said Christian Schulz, an economist at Berenberg Bank in London who used to work at the ECB. “The conditionality was devised to appease and bring on board the traditional Bundesbank allies, who would have shared a lot of the Bundesbank’s concerns. It’s more vital than ever for Draghi to have them on side.”
Draghi stressed the “strict conditionality” of the program in a speech in Frankfurt yesterday as he seeks to assuage German concerns.
Conditions were put in place “largely to please Germany,” said Jennifer McKeown, senior economist at Capital Economics in London, who also thinks the decision to sterilize the bond purchases was due to Weidmann. “Given that the Bundesbank has only one vote at the ECB, one might argue that it has actually exerted undue influence in these matters,” she said.
Under so-called Outright Monetary Transactions, the ECB will only buy a nation’s bonds on the secondary market if the government requests aid from Europe’s rescue fund and signs a Memorandum of Understanding to meet certain fiscal targets. Even then, there is no guarantee the ECB would intervene.
That’s giving Spain cause for pause.
Spanish Prime Minister Mariano Rajoy said this week he needs to know how much the country’s borrowing costs will fall before he seeks a rescue. Bond yields have already dropped and there’s no point seeking a bailout if they don’t fall any further, he told Cope Radio.
Spanish 10-year yields climbed to 5.83 percent today. That’s still down from 7.62 percent on July 24, two days before Draghi said he would do whatever is needed to preserve the euro.
The longer Rajoy resists, the higher the risk that investors will lose patience and force him to seek aid, paving the way for the ECB to start buying Spain’s bonds.
ECB council member Ewald Nowotny told Handelsblatt this week that the ECB should buy bonds to demonstrate to financial markets “that we have a powerful tool.”
The ECB’s willingness to re-enter debt markets represents a significant defeat for the Bundesbank, whose policy makers have argued against such measures since the first purchase program started in May 2010.
“With the OMT, the Bundesbank has lost an important fight,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London. “Even if it might have convinced the others to consider some conditions, the entire OMT goes against the Bundesbank’s ideas.”
Weidmann and Draghi have done little to dispel the notion that the bond plan has caused a rift between them.
Draghi took a swipe at the Bundesbank president on Sept. 25, criticizing his “nein zu Allem,” or no-to-everything approach. For his part, Weidmann has given speeches around Germany on the need for the ECB to preserve the value of the euro and the dangers of printing money.
The key to Draghi getting his plan through without Weidmann’s backing was the support of German Chancellor Angela Merkel, whose split with the Bundesbank on the issue is “one of the most ground-breaking events this year,” said Jacques Cailloux, chief European economist at Nomura International in London.
Weidmann is far from a spent force, said Huw Pill, chief European economist at Goldman Sachs in London, who thinks the Bundesbank may still wield enough power to limit whatever bond-market interventions the ECB eventually makes.
“It’s a pole around which others will coalesce,” he said. “If you add up the votes on the ability to do very proactive purchases, to put it bluntly, I just don’t think the votes are there.”