ECB Ready to Test Freedom to Act With New Tools for Greek Crisis

The European Central Bank claims it’s won itself more freedom of action just in time to handle any fallout from Greece’s crisis.

Executive Board member Benoit Coeure says a court ruling ending almost three years of ambiguity on the legality of one of its crisis-fighting tools gives officials “broad discretion,” and they can now develop “new instruments” to rein in market volatility if needed. That might prove crucial if the ECB wants to move swiftly to prevent contagion from Greek turmoil.

“The ECB is taking ownership of the tail risk associated with Grexit,” Krishna Guha, vice chairman of Evercore ISI in Washington, said in a note. It is “hoping thereby to stabilize risk spreads and risk premia, in particular on periphery sovereign debt and periphery banking systems.”

Coeure’s reasoning, in an interview with Les Echos, is based on a European Court of Justice ruling that the ECB acted within its mandate in 2012 when it announced Outright Monetary Transactions, a targeted bond-buying program aimed at calming investor fears that the euro area would splinter. While OMT could help to stop Greece’s crisis spreading beyond its borders, the conditions attached would slow its implementation.

An ECB spokesman declined to elaborate on Coeure’s comments.

Never Used

Prime Minister Alexis Tsipras’s July 5 referendum on whether to accept an incomplete bailout proposal by its creditors puts Greece on the cusp of a financial collapse that could see it become the first country to leave the currency bloc. Any consequent volatility in financial markets could undermine the region’s fragile economic recovery, so prompting the ECB to step in.

OMT allows the central bank to buy the bonds of a specific country to curb yields that it deems are at levels that hinder the transmission of monetary policy. The condition is that the nation’s government applies for a financial-assistance program, which would require political approval. It has never been used.

“The signal from Mr. Coeure appears to be that the ECB have been creative in the past and could continue to be so in the future,” said Nick Matthews, senior European economist at Nomura International Plc in London. “One limitation with OMT -– aimed at safeguarding an appropriate monetary-policy transmission and the singleness of monetary policy -- is that it is not available immediately.”

Adjusting Modalities

Another option, the current quantitative-easing program, applies across the currency area in proportion to the capital keys of each national central bank in the ECB, effectively the relative size of each economy. Simply increasing or accelerating purchases would center on stronger nations such as Germany that don’t need help. That might mean the ECB needs to tweak the program.

“They could easily adjust the modalities and temporarily deviate from the rules that they have set, in particular the breakdown of capital keys” said Frederik Ducrozet, an economist at Credit Agricole SA in Paris. “They could use QE but they could extend it to corporate bonds in the periphery. It’s a very small market, but it could have some positive spillover effects.”

The alternative though is to come up with something completely new, focusing on countries facing market stress, without attaching conditions, on the basis that the ECB is acting in the interest of the euro area as a whole. A similar argument carried the day for OMT with European judges.

“The ECB has always found answers to crises,” Coeure said. “We are ready to do more in terms of monetary policy, if necessary.”

For Erik Nielsen, global chief economist at UniCredit SpA in London, there’s no need for ECB officials to be too clever.

“With QE in place and the OMT they have all the tools in the eurozone they need,” he said. “I don’t personally see that there’s any gap in the arsenal when it comes to the euro zone.”