By Richard Barley
The market verdict was clear: Mario Draghi had written a check he
couldn't cash. The European Central Bank president promised last week
to do "whatever it takes" to save the euro but the ECB didn't actually
do anything at Thursday's meeting. Ten-year Spanish bond yields
promptly rose back above 7%, and stock markets and the euro fell.
But the market reaction is not entirely fair. Mr. Draghi's previous
comments may have raised expectations too high, but he has provided
the broad outlines of a plan for ECB intervention in government bond
markets. That is certainly a step forward.
In particular, Mr. Draghi made two important points. First, that the
ECB would only intervene in markets alongside the euro zone's bailout
funds. This is crucial for the ECB because only the European Financial
Stability Facility and its successor, the European Stability
Mechanism, can ensure binding conditionality. A key weakness of the
ECB's previous bond-buying programs was that it relied on policy
promises that politicians then failed to keep.
Second, Mr. Draghi said investor concerns over ECB seniority would be
addressed. The ECB's old Securities Markets Programme has been
effectively unusable since the central bank refused to take losses on
its Greek bonds, leading to even bigger haircuts for private-sector
bondholders. But how the ECB will structure any new program to avoid
this problem is unclear.
There are still plenty of other unanswered questions too. Mr. Draghi
said any intervention would be of a size "adequate to meet its
objective." But what form will any future intervention take? How will
the ECB define its objective? Is the ECB's commitment open-ended? Mr.
Draghi hinted that any new program would focus on the shorter part of
the yield curve, which would appear to have put a constraint on the
scale of any ECB operation.
Mr. Draghi said these details would be discussed in the coming weeks.
But a key concern for investors is whether the ECB can deliver on
these plans given the clear opposition of the Bundesbank. Mr. Draghi
acknowledged that one country opposes bond-market interventions. The
Bundesbank only has one vote out of 23 on the ECB's Governing Council,
so has no formal right of veto. But in practice, Mr. Draghi will be
wary of defying his biggest shareholder.
Spain will now come under great pressure to ask the euro-zone bailout
funds for help with lowering its borrowing costs, something it has
been desperate to resist. That in turn will reignite questions about
the capacity of these funds. Worse, ratings firms may decide that
asking for aid is enough to justify further downgrades, causing more
problems.
Mr. Draghi's credibility is on the line. At the very least, the euro
zone faces a long hot summer until his plans become clearer.
(Richard Barley is a writer for Heard on the Street. He has covered
the European bond market in one form or another since 1998. He can be
reached at +44-20-7842-9406 or by email: richard.barley@dowjones.com;
follow him on Twitter at @RichardBarley1)
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(END) Dow Jones Newswires
August 02, 2012 13:00 ET (17:00 GMT)
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