Draghi: ECB preparing, but governments must act
FRANKFURT (MarketWatch) -- European Central Bank President Mario Draghi said the institution might intervene in bond markets to help bring down borrowing costs for struggling euro-zone countries, but will only act after governments ask for help from the region's rescue funds, disappointing investors banking on immediate action.
In the event of extreme market turmoil, "governments must stand ready to activate the [European Financial Stability Facility and the European Stability Mechanism] in the bond market," Draghi said at his monthly news conference. Read "Draghi doesn't back up the talk."
Countries that use the facilities would have to adhere to strict conditions on fiscal and economic policy.
The ECB, meanwhile, may be prepared to "undertake outright market operations of a size adequate to reach its objective," Draghi said, adding that the bank might also consider other nonstandard measures depending on what is needed to repair the transmission of monetary policy.
Markets turned south, with Spanish government bonds tumbling sharply, sending yields soaring. The yield on Spain's 10-year government bond jumped nearly half a percentage point to 7.16%, according to Tradeweb. Yields above 7% raise warning flags, after similar moves preceded bailout recipients Greece, Portugal and Ireland finding themselves effectively shut out of credit markets.
"Markets have lost faith in the ECB's ability to step up to the plate, even though they probably overstepped the mark by thinking this was going to happen anytime soon," said Simon Smith, chief economist at FxPro in London.
Earlier, the ECB announced it had left its key lending rate unchanged at a record low 0.75%, as expected.
Draghi last Thursday triggered a global rally in equities, while Spanish and Italian government bond yields pulled back from crisis levels.
"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough," Draghi said at an investment conference in London last week.
Draghi on Thursday vociferously dismissed notions he had overpromised, saying he stood behind the remarks and that the comments were no surprise to fellow members of the ECB's Governing Council.
That led Carl B. Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y., to quip, in a note: "Translation: I cannot deliver the promises I implied in my London speech last week…you must have misunderstood me."
Draghi reiterated his declaration that the euro is "irreversible," saying "it's pointless to bet against" the survival of the shared currency.
While the central banker worked hard to avoid the impression he was backpedaling from his London speech, it's clear that the ECB is adopting a "supporting role," said James Nixon, euro-zone economist at Société Générale.
The ECB is "prepared to enhance and mirror the firepower of the [European Financial Stability Facility or the European Stability Mechanism], but there will be no bond buying until a country formally requests assistance."
The EFSF is the region's temporary rescue fund, while the ESM is the permanent fund. The ESM is expected to be up and running next month provided it passes muster with the German Constitutional Court, which is scheduled to rule Sept. 12 on challenges to its legality.
Several economists had warned that the ECB was likely to disappoint, noting that a resumption of bond purchases by the central bank would be easier to implement once Spain agreed to seek help from the EFSF--something Prime Minister Mariano Rajoy has been reluctant to do.
In a news conference in Madrid Thursday afternoon, Rajoy and Italian Prime Minister Mario Monti welcomed Draghi's remarks but gave no indication either country was ready to apply for help from the EFSF, news reports said.
Economists had also argued that a lack of faith in the efficacy of the ECB's bond-buying program and stiff opposition by Germany would prompt Draghi to attempt to lay groundwork for bolder action later. Read earlier story about Bundesbank opposition.
For his part, Draghi implied the operations envisioned by the ECB could be bolder than those undertaken through the bank's controversial Securities Market Program.
Draghi said the central bank and its various committees had yet to determine whether the program would be "unlimited or limited" or whether purchases of bonds would or wouldn't be sterilized by draining an offsetting amount of reserves from the financial system. A lack of sterilization could amount to a form of quantitative easing.
Bond purchases would be transparent, Draghi said, with the ECB announcing the size of the measures and the amount of each country's bonds it had purchased. Under the SMP, the bank reveals the amount of bonds bought, but offers no country-by-country breakdown.
The program would also focus on the shorter end of the yield curve, since the objective is to restore the monetary policy transmission mechanism, he said.
Draghi said the ECB Governing Council would vote at a later date on a final plan. He said the measures outlined weren't voted on as a formal proposal Thursday, but noted that one member, presumably Bundesbank President Jens Weidmann, expressed reservations about bond purchases.
Draghi also said the central bank would address investor concerns over Bundesbank seniority if it returns to the bond market, but refused to offer any further details.
That is an issue because the European Central Bank's decision to not participate in the restructuring of Greek government debt raises fears that any future restructuring of Spanish government debt would see private bondholders subordinated once again, strategists said.
In other words, the more bonds the central bank buys, the bigger the hit that private bondholders would potentially take in the event of a restructuring.
Draghi again dismissed talk of issuing a banking license to the ESM.
Earlier, the Bank of England, as expected, said its Monetary Policy Committee voted to leave the key lending rate at a record low of 0.5%. The MPC also voted not to alter the plan initiated last month to increase the size of its stock of asset purchases to 375 billion pounds ($583 billion) from £325 billion.
The central bank, which raised the size of its asset-buying program by 50 billion pounds last month, said it expects purchases to take another three months to complete. "The scale of the program will be kept under review," the bank said. Minutes of the August policy meeting will be released on Aug. 15.
The bank's Funding for Lending program, aimed at boosting bank lending to the real economy, just got under way. Economists said the Bank of England is likely to want to see the current bond purchases run their course and to gauge the impact of the new lending program before taking additional steps.
"We do not expect any further policy changes until the November MPC meeting at the earliest. Even then, we suspect it would be an expansion of QE over an interest-rate cut," said James Knightley, economist at ING.
The British pound (GBPUSD) traded at $1.5504, down 0.3% on the U.S. currency unit, and off slightly from around $1.5555 just ahead of the announcement.