Both Paul Murphy and Joseph Cotterill at FT Alphaville aren’t quite so convinced that Mario Draghi’s big policy statement yesterday was a complete and utter flop. True, the European Central Bank (ECB) refrained from using its considerable firepower to bring down borrowing costs for Italy and Spain, as many had hoped. That led to some early panic in the financial markets.
But Draghi did indicate that the ECB “may consider” buying up, directly or indirectly, the bonds of countries like Spain and Italy in the future. And that, in itself, could prove to be a significant shift. Paul Murphy passes along this commentary from Olaf Storbeck, an economics correspondent with German business daily Handlesblatt:
Between the lines the message was perfectly clear. The Bundesbank might not like it, but the ECB will intervene in the bond markets in the foreseeable future. And big time.
From my perspective, the most important piece of the speech was Draghi’s implicit acknowledgement that the ECB has a target rate for bond yields. Draghi described the current yields as unacceptable and he stressed that the ECB “may undertake outright open market operations of a size adequate to reach its objective”.
He did not reveal where the ECB’s pain barrier is. However, the mere acknowledgement that the ECB has a certain threshold in mind is quite something. If Draghi means what he says, it follows that the bank is ready to buy bonds without any limits.
Let’s parse this a bit. At its Thursday meeting, officials at the European Central Bank were debating whether to start intervening in order to bring down borrowing costs for countries such as Spain and Italy. Remember, if Spain and Italy have to pay too much to borrow money (say, because investors are losing confidence in the future of the euro), then those countries risk hitting an unsustainable cycle of doom. Their debts go up, which raises their borrowing costs further, which means their debts go up further… repeat until apocalypse.
So, in response Draghi suggested that the European Central Bank might not let bond yields rise above the point where doom sets in. And, since the ECB can print euros, it can credibly make that promise. If Draghi pledges to intervene in the Spanish debt market until Spanish bond yields get below a certain point, few people are going to bet against the man with the printing press. (Though, as Storbeck notes, Draghi did not reveal what that danger threshold actually was.)
What’s more, Draghi was suggesting that he’d be willing to take this step even though the German Bundesbank, the richest and most powerful shareholder in the ECB, disapproves of any sort of central-bank sovereign bailout for Spain and Italy. Jens Weidmann, the German representative on the ECB board, was the lone dissenter from the new bond-buying proposal. And Weidmann couldn’t get any of the other members to agree with him.
As Daniel Davies says, “In the long term, we will look back on the most significant thing at [Draghi's press conference] as the news that Weidmann objected but was outvoted.” That could well indicate a subtle power shift at the European Central Bank.
In any case, the financial markets seem to be a bit happier with Draghi’s policy statement today. Whether that lasts, however, is another matter altogether. Over the past three years, we’ve seen countless bold new proposals to hold the euro zone together. Financial indicators usually tick up brightly for awhile, and then panic sets in once everyone realizes that the bold new proposal wasn’t actually enough.