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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’.
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 Forex.com 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.
More about this:
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- How it all went wrong for Spain
- LTRO is biggest 'cash for trash' scheme in the world
- What is 'LTRO' and how does it work?
- Market Blog: FTSE rises as ECB vows to save eurozone
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by Michelle McGagh on Dec 12, 2013 at 10:57