ECB Holds Rates as Draghi Stakes Credibility on Bond-Buys
Policy makers meeting in Frankfurt left the benchmark rate at a record low of 0.75 percent, as predicted by 28 of 58 economists in a Bloomberg survey. The remainder forecast a quarter-point cut. Investors are focused on Draghi’s press conference at 2:30 p.m., when he may announce details of a plan to intervene in bond markets to help restore transmission of ECB interest rates.
“The ECB is keeping its powder dry for now and will probably cut rates next month,” Jens Kramer, an economist at NordLB in Hanover, said before the decision. “All eyes are on the bond plan today. Cutting rates won’t really have an impact, but it would be an additional signal that the ECB will throw its full arsenal at saving the euro.”
Draghi pledged more than a month ago to do what’s needed to preserve the single currency. Now he’s under pressure to follow through with details of a bond-purchase plan to lower borrowing costs in Spain and Italy and prevent a breakup of Europe’s monetary union. Expectations have built to such an extent that Draghi risks losing credibility unless he delivers, economists and investors said.
Credibility at Stake
The ECB holding rates suggests policy makers may have reached agreement on the bond-purchase plan. The euro rose to the highest since July 2, climbing 0.3 percent to $1.2642. German two-year yields added four basis points to 0.02 percent at 12:49 p.m. London time. The 10-year bund yield rose two basis points, or 0.02 percentage point, to 1.50 percent.
“Draghi has put his credibility squarely on the line,” said Julian Callow, chief European economist at Barclays in London. “He has made it his business to save the euro, so he is going to be called on that.”
Draghi told the European Parliament this week that the ECB needs to intervene in bond markets to wrest back control of interest rates in a fragmented euro-area economy and save the currency, according to a recording of a closed-door session obtained by Bloomberg News.
His blueprint, sent to council members just two days ago and opposed by Germany’s Bundesbank, proposes unlimited buying of government debt with maturities of up to about three years, two central bank officials said yesterday on condition of anonymity.
Separately, the Bank of England kept its key rate at 0.5 percent today and maintained its bond purchase target at 375 billion pounds ($597 billion). Sweden’s Riksbank unexpectedly cut its key rate by a quarter point to 1.25 percent, caving in to calls from exporters to stem the rise of the krona.
The ECB’s 23 council members had a full agenda today. In addition to discussing rates and the modalities of Draghi’s asset-purchase plan, they also considered new economic projections and decided whether to loosen rules on the collateral banks can submit in return for central bank loans.
Still, the focus is on the bond purchases and Draghi “has set the bar very high for market expectations,” said Andrew Bosomworth, head of Pacific Investment Management Co. in Germany. “To not disappoint, the ECB will have to make its reaction function transparent and at least spell out the maturities it is going to buy.”
Draghi’s plan involves the ECB buying short-dated bonds on the secondary market of countries that ask Europe’s bailout fund to purchase their debt on the primary market, which would require them to sign up to conditions. Neither Spain nor Italy has made such a request yet.
Draghi’s rationale for the purchases is that ECB interest rates are not being transmitted in most euro-area countries because investors are pricing in the risk of a breakup, something he considers unacceptable. The ECB must regain control of rates in order to fulfill its primary mandate of price stability, he told lawmakers in Brussels on Sept. 3.
The ECB will sterilize its purchases to soothe concerns about printing money, two officials said yesterday. The ECB won’t have seniority on any bonds it buys, and no yield-spread targets or bands will be set publicly, they said.
Draghi will stress the conditionality of the program, with the ECB likely to stop buying the bonds of any government that fails to meet the terms it agrees to when it signs up for aid from Europe’s rescue fund, the people said.
Prime Minister Mariano Rajoy and German Chancellor Angela Merkel meet in Madrid today to discuss the euro crisis and are due to hold a joint news conference at about 2:30 p.m., the same time Draghi speaks.
Draghi is walking a tightrope, said Ken Wattret, chief euro-area economist at BNP Paribas SA in London.
Because Italian and Spanish bond yields have dropped in anticipation of ECB action, there’s a risk that the two countries won’t see the need to ask for help, Wattret said. On the other hand, disappointment with Draghi’s plan today may trigger a market selloff that “could be the circuit breaker that forces Spain at least to ask for aid,” he said.
Spain’s two-year yields dropped to as low as 2.99 percent today from a euro-era high of 7.15 percent on July 25. Italy’s two-year yields have dropped almost three percentage points over the same period.
Spain today sold 3.5 billion euros ($4.4 billion) of bonds, meeting its maximum target for the sale. The average yield for debt maturing in 2016 fell to 4.603 percent from 5.971 percent on Aug. 2. The rate on notes due in 2015 declined to 3.676 percent from 5.086 percent in July and 2014 securities were sold at 2.798 percent, compared with 4.706 percent in June.
The ECB has been at the forefront of fighting the debt crisis, which has so far pushed five countries into bailouts and driven the 17-nation euro economy to the brink of recession.
In addition to governments dragging their heels, Draghi’s bond-purchase plan faces opposition from German policy makers, politicians and executives.
“An unlimited and far-reaching intervention by the central bank by buying sovereign debt is beyond the mandate of the ECB,” Commerzbank AG Chief Executive Officer Martin Blessing said at a banking conference in Frankfurt yesterday. “I cannot image how one can build trust and a strong currency union by violating the law. There is the danger that we keep on buying time while the pressure to reform is declining.”
Germany’s Constitutional Court could also throw a spanner in the works when it rules on the legality of Europe’s permanent bailout fund, the European Stability Mechanism, on Sept. 12.
“The ECB is taking a leap of faith that governments will pursue and implement the reform agenda,” Bosomworth said. Still, unlike in the past, “there is more of an awareness among governments about how important this is,” he said.
Draghi’s bond-purchase plan won’t solve Europe’s debt crisis, said Erik Nielsen, global chief economist at UniCredit Bank AG in London. “But he’s fed up with markets pricing in euro-area breakups, and I wouldn’t mess with him if I were a trader.”
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