ECB Policy Maker Says Bank May Not Spend a Cent on Bonds
European Central Bank Governing Council member Panicos Demetriades said the bank might not have to spend a cent on government bonds.
The threat of unlimited buying under the ECB’s new bond- purchase program may mean that “in the end, action is not needed,” Demetriades, who heads the Central Bank of Cyprus, said in an interview in Nicosia yesterday. “No one will speculate against the unlimited firepower of a central bank. This is what stabilizes currencies of countries where investors know that. One wouldn’t gamble against the Federal Reserve, for example.”
Spanish and Italian bond yields have plunged since ECB President Mario Draghi pledged on July 26 to do what’s needed to preserve the euro. Under Draghi’s so-called Outright Monetary Transactions program, unveiled on Sept. 6, the ECB would spend as much as needed to contain borrowing costs in euro-area countries if they sign up to bailout conditions first.
“A central bank has this wonderful ability that no other player in the market has when it says ‘I’m going to do whatever it takes,’ and everyone believes that,” Demetriades said. “In the end, they may do nothing.”
The ECB spent about 220 billion euros ($284 billion) under its previous, limited, bond-buying program.
The euro fell after the comments were published before recovering to trade at $1.2913 at 2:34 p.m. in Frankfurt, up 0.1 percent on the day. Italy today sold 4 billion euros of its benchmark three-year bond to yield 2.5 percent, the lowest rate in almost two years.
“Demetriades is sketching out the ECB’s best-case scenario, where they ensure financing for Spain and Italy at low rates without spending a cent,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. “While this is a possibility, I think it is more likely that the central bank will need to intervene in the bond market eventually.”
Demetriades, 53, joined the ECB’s 23-member Governing Council in May when he replaced Athanasios Orphanides as the central banker for the euro area’s third-smallest economy.
Cyprus, which hosts a meeting of euro-area finance ministers tomorrow, asked the European Union for a bailout in June. Demetriades said he hopes one will be agreed “as soon as possible,” though he doesn’t expect it to happen this month.
With the sovereign debt crisis pushing the 17-nation euro economy to the brink of recession, the ECB cut its benchmark rate to an historic low of 0.75 percent in July and lowered its deposit rate to zero.
Asked whether the ECB could cut interest rates further, Demetriades indicated the Governing Council may not be ready to take the deposit rate into negative territory.
“Of course there are downside risks now, and when it comes to next month’s decision we take on board all the developments and decide accordingly,” he said. “I don’t think we are technically ready for negative deposit rates, but I don’t see that, in theory at least, as an obstacle.”
In the absence of “any” inflation risks, there’s no real need for the ECB to sterilize any bond purchases by withdrawing as much liquidity as it injects, Demetriades said.
“I think that discussion is overrated,” he said. “In the current circumstances even if the ECB were not able to sterilize, I don’t think it would make any significant difference.”
Demetriades, a former World Bank official who worked under Nobel Prize-winner Joseph Stiglitz in the aftermath of the Asian financial crisis, said Europe needs to re-think its approach to fiscal consolidation.
“We need to shift toward programs that emphasize more growth,” he said. “Fiscal consolidation is more successful if it does not hamper growth.”
Cyprus is seeking to avert the severity of austerity measures that have crippled neighboring Greece. Demetriades told lawmakers on the eastern-Mediterranean island in July that the banking sector may need more than 12 billion euros in external aid. He said yesterday it’s premature to talk about numbers “because we have to wait for the completion of the diagnostic check by independent assessors.”
The EU yesterday unveiled proposals that would give the ECB oversight of all euro-area banks. The central bank would become the top-level supervisor, accruing powers including the ability to fine non-compliant banks, issue banking licenses and instruct lenders to carry out stress tests.
“What we need to do in the euro area is decouple sovereign risk from bank risk,” Demetriades said. “For countries like Cyprus with large banking systems, it is particularly important. A central bank has to have powers. That’s critical for monetary union. I don’t see that as a danger.”
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