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Week Ahead: ‘whatever it takes’ to save the euro

If European bank chief Mario Draghi doesn’t deliver then investors – who have already ‘bought the rumour’ – will ‘sell the fact’.

Week Ahead: ‘whatever it takes’ to save the euro

Hard-working central bankers need holidays too. While European politicians take a rest from the crisis devastating euro-area countries,  Mario Draghi, the head of the European Central Bank, has assumed responsibility for bashing together a rescue effort – at least until he can hand the baton back to politicians after the summer lull.

Draghi yesterday pledged to do ‘whatever it takes’ to save the euro, to the delight of markets.

If he doesn’t deliver a suitably grand follow-up then investors – who have already ‘bought the rumour’ – will ‘sell the fact’, as Kathleen Brooks of warns.

The obvious staging point for action to stem the rise in Spanish and Italian borrowing costs, which is leading to talk of full-scale bailouts, is when the ECB’s governing council meets in Frankfurt to decide on policy on Thursday. Of three major central bank gatherings next week – the Bank of England and US Fed also meet – the ECB is thought most likely to throw more support at markets, with the other two holding fire.

What might that support be? Changes to interest rates are thought unlikely, and not necessarily that effective just a month after the ECB last cut rates.

Instead, Draghi’s bank has a flashy array of acronyms, but none of them is straightforward, and they all suffer from political complications or simple limitations on how effective they will be.

The re-activation of the SMP, a scheme to buy troubled peripheral nations’ sovereign bonds, seems to be the favourite (or several variations providing it with guarantees). Economists reckon this could make a big splash in thin summer markets, bringing down peripheral bond yields. It’s a temporary solution, buying time until a German court gives its verdict on the eurozone’s ‘ESM’ bailout fund, the longer-term scheme which replaces the short-term ESFS bailout pot.

The problem with the SMP scheme, though, besides some political opposition, is that it didn’t work last time. ECB buying of Portuguese and Irish bonds in the past was followed by their bailouts. That could be the point though – Draghi sustains things until the politicians can conjure up more elaborate tricks.

The SMP is a secondary market tool, buying up bonds that are already out there. Alternative measures would involve buying bonds straight from the governments issuing them at auction.

The EFSF/ESM funds could theoretically do this… only they are running terribly short on cash. A QE scheme likewise would have limited financial firepower. This is where the idea of granting the eurozone’s bailout fund a banking licence comes in. That way it could borrow from the ECB and never run short of funds. Austria’s central bank governor, Ewald Nowotny, gave markets a brief boost earlier this week when he hinted again at this plan, but Draghi has spoken against it. Besides, this wouldn’t happen before the German court decision in September. 

Or the ECB could encourage commercial banks to buy up bonds from governments. The LTRO scheme of cheap loans to banks – the biggest 'cash for trash' scheme in the world – is one way to do this, if it were to be given a third life. This is another politically fragile mechanism that comes with the added disadvantage that it maintains the poisonous tie between banks and governments.

7 comments so far. Why not have your say?


Jul 28, 2012 at 16:43

I take it that from all these shenanigans the free market economy is dead.

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Jul 29, 2012 at 10:03

The Free Market will win in the end

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Calm down and think it through

Jul 29, 2012 at 10:55

When Mario Draghi pledged to do whatever it takes to save the euro, many people interpreted that to mean that he will do what they think he should do. As there is no broad agreement as to what should be done, many will be disappointed.

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Jul 29, 2012 at 11:36

Draghi also used the limiting words "Within our Mandate"

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mark antrobus

Jul 29, 2012 at 16:34

However any solution is packaged and presented it will only work if it involves the European Central Bank creating a lot of new money. This would need to be used to buy up and even cancel the sovereign debt of member states. If this works well then fine, but even if it doesn't then do it even more - this is free money and the interest payments received by the Bank can be paid back to member states. And if all this extra money adds to Aggregate Demand in the Euro Zone even better - that is exactly what is needed to reduce the 25% levels of unemployment needed in Spain, Greece etc, that is as high as in the Great Depression. No doubt there will always be someone who says this cannot be done because it will lead to inflation. It can only be assumed that by the same logic they would not give food to a starving person in case it made them fat.

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smoking gun

Jul 29, 2012 at 17:06

More procrastination. When are they really going to do something? Its months now since everyone said if it wasn't solved by a particular date the Euro was destined to fail.. Well that date is long past and they still haven't a clue where they are going.

They say its "not knowing" that causes the upheaval in economic circles. Why don't they simply get Greece and maybe Spain Italy Portugal and even the Irish out until THEY manage to sort themselves out. At least the rest of the world would know where they were going. Let's be frank: Economists, bankers and lawyers should never be allowed to become politicians in charge of anything.

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Jul 29, 2012 at 20:33

Che sera sera....

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