Last week, analysts waxed optimistic about the crisis in Europe after Mario Draghi, the continent’s powerful central banker, said he’d do “whatever it takes” to save the euro from collapse. “Believe me,” he said, “it will be enough.” And financial markets mostly believed him. There was just that nagging question of whether Germany would allow Draghi to act decisively.
But now it’s less clear whether Draghi will follow through on his pledge, after all. On Thursday, at the conclusion of the European Central Bank’s August meeting, Draghi issued a new statement clarifying what he meant. No, he wouldn’t be buying up Spanish and Italian bonds right now in order to bail out those troubled countries, as many people were speculating. Instead, the ECB “may consider” doing so at a later date. Possibly. Here’s the key part of the statement:
The Governing Council extensively discussed the policy options to address the severe malfunctioning in the price formation process in the bond markets of euro area countries. Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.
In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, 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 in line with the established guidelines.
The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.
Short version: Yes, it’s worrisome that borrowing costs for Spain and Italy are soaring. And the governments of Europe should press ahead with finalizing their new bailout fund in order to stem the panic. One problem here is that the two European bailout funds — the European Financial Stability Facility and its yet-to-be-approved successor, the European Stability Mechanism — don’t have unlimited firepower the way the central bank does. (Spain and Italy have also been reluctant to seek help from the existing fund, since creditor nations like Germany could demand further austerity and structural reforms as the price of aid.)
So, Draghi adds, the central bank “may consider” stepping in and helping out in the future to reduce excessive borrowing costs for Spain and Italy. But there are still some technical kinks to work out, and the European Central Bank needs to “design the appropriate modalities for such policy measures.” Action could be months away.
What’s the hold up? Germany, perhaps. During a press conference afterwards, ECB vice-president Vítor Constâncio noted that only one member of the ECB was adamantly opposed to bond purchases. This seems to be a reference to Germany’s Bundesbank, which had vigorously opposed a central-bank bailout of Spain and Italy. And even though the Bundesbank doesn’t have a direct veto over ECB actions, it seems Germany, as the richest country in the euro zone, still has plenty of sway.
In any case, it appears that quite a few people were expecting a lot more than “appropriate modalities” and hints of future action. Here’s the Spanish stock market Thursday. Spot the moment when Draghi’s news conference got into full swing:
Update: For a more optimistic counter to financial markets, read Joseph Cotterill’s breakdown of Draghi’s statement over at FT Alphaville. He notes that some of the technical details inhibiting bond purchases are really quite difficult, and will take some time to overcome. “Today’s statement could only say policies are in the design stage,” Cotterill concludes. “But again we find the view that this in itself presages disaster curious.”