Thursday, September 6, 2012

Mario Draghi's pudding

At today’s meeting, the ECB kept interest rates on hold and presented details of its new bond buying programme. Mario Draghi truly presented his “believe me it is enough”. Now the ball is back with Eurozone governments.

The ECB’s macro-economic assessment was clearly not top priority of today’s meeting. The ECB’s staff projections have hardly received so little attention as today. In its macro-economic assessment, the ECB acknowledged a further deterioration of the economic situation in the Eurozone. In the latest ECB staff projections, GDP growth forecasts for both this and next year were revised downwards. ECB staff now expected GDP growth to come in at -0.4% (from -0.1% in June) and 0.5% (from 1%) for next year. As regards inflation, the projections were revised slightly upwards to 2.5% (from 2.4%) for this year and 1.9% (from 1.6%) for next year. As the economic assessment might still be too positive, a rate cut in the coming months looks still possible.

All eyes were focussed on the ECB’s possible plan for bond purchases. By keeping interest rates unchanged, the pressure to at least deliver on the plan had increased even further. And, indeed, ECB president Draghi delivered the new ECB bazooka: the so-called OMT (outright monetary transactions) programme.

With the start of the OMT, the old SMP will be officially put to an end. According to the ECB, the new OMT is aimed at “safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”. A clear attempt to present it as a pure monetary policy tool and not as a way to finance governments in need. As expected, the OMT will be conditional on an EFSF/ESM programme. According to the ECB, such a programme does not necessarily have to be a fully-fledged bailout package but could also be a precautionary programme. As the ECB said “involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme”. In our view, all of this means that the ECB will only activate its OMT programme if a country in question has agreed on a so-called Memorandum of Understanding with the Troika and if EFSF/ESM engages in purchases in the primary market. The OMT will be focused on the short end of the yield curve on, in particular, sovereign bonds with a maturity of between one and three years. The OMT will not only be applied to future bailout candidates but could already be started for Eurozone countries currently under a macroeconomic adjustment programme once they start to regain bond market access (which seems to be a rather stringent condition in our view).

Bond purchases under the OMT programme will be sterilised and the ECB will not take a senior status on its holdings. When and how the ECB plans to intervene, however, was not disclosed. It seems as if there will not be any explicit targets. The ECB only plans to announce its purchases ex post on a weekly and monthly basis. In addition to the OMT programme, the ECB also announced that it will accept government bonds as collaterals independent of their credit ratings (except for Greek bonds).

All in all, the ECB has presented a big new bazooka which should help buying time. This is probably he furthest the ECB can go to help governments. The focus on the monetary policy transmission and strict conditionality should also calm the Bundesbank temper, even if they would not admit it. However, the emphasis on the transmission mechanism is also a danger as it still contains a logical contradiction. With the OMT, the ECB will only repair the transmission mechanism in countries with ask for EFSF/ESM. But what about the other countries? It remains a bit strange. For the time being, one thing is clear: never underestimate Mario Draghi. He clearly delivered on his “believe me it will be enough” announcement. A man, a word. But as he said himself: “the proof is in the pudding”.

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