ECB's Mario Draghi unveils bond-buying euro debt plan

 

ECB president Mario Draghi: "We will have a fully effective backstop to avoid destructive scenarios"

Mario Draghi, president of the European Central Bank, has unveiled details of a new bond-buying plan aimed at easing the eurozone's debt crisis.

He said the scheme would provide a "fully effective backstop" and that the euro was "irreversible".

The ECB aims to cut the borrowing costs of debt-burdened eurozone members by buying their bonds.

The Spanish government's implied borrowing costs fell sharply after the announcement.

Mr Draghi said the ECB would engage in outright monetary transactions, or OMTs, to address "severe distortions" in government bond markets based on "unfounded fears".

He insisted that the ECB was "strictly within our mandate" of maintaining financial stability, but reiterated the need for governments to continue with their deficit reduction plans and labour market reforms.

He added that the ECB's actions came in response to eurozone economic contraction in 2012, with continued weakness likely to continue into 2013.

The ECB expects the eurozone economy to shrink by 0.4% in 2012 and grow by 0.5% in 2013, with inflation rising to 2.6%.

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Some in the financial markets - and many governments - will certainly be disappointed that it has taken so long for the ECB to step up to the plate”

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OMTs will only be carried out in conjunction with European Financial Stability Facility or European Stability Mechanism programmes, he said.

In other words, countries will still have to request a bailout before the OMTs are triggered.

The maturities of the bonds being purchased would be between one and three years and there would be no limits on the size of bond purchases, he added.

The ECB will ask the International Monetary Fund to help it monitor country compliance with its conditions.

Market reaction

Mr Draghi is hoping that ECB intervention in the bond markets will help reduce the borrowing costs of debt-laden countries such as Spain and Italy and lessen the likelihood of them needing to ask for a full sovereign bailout, an eventuality that could bankrupt the eurozone and cause the collapse of the euro.

Analysis

This new proposal is different from the ECB's previous bond-buying programme in important ways.

The bank accumulated more than 200bn euros in bonds issued by Greece, Ireland, Portugal, Italy and Spain under its Securities Market Programme, but those purchases were always described as limited, and they were never accompanied by any formal conditions.

The OMT, on the other hand, is described by Mr Draghi as potentially unlimited in size.

Countries will first have to apply for assistance to eurozone bail-out funds, and they will have to agree to 'strict and effective' monitoring of efforts to reform their economies.

Ideally, the ECB would like the International Monetary Fund to be involved in that process too, and the Fund says it is ready to co-operate.

It all begins to sound like 'bail-out lite' - and it puts the ball firmly in the court of political leaders like Mariano Rajoy in Spain and - a little further down the line - Mario Monti in Italy.

They will have to decide whether they want more intrusive external surveillance of their economies - something they have been keen to avoid.

Spain is already benefiting from investors' response to the plan.

Earlier in the day, the Spanish government raised 3.5bn euros on the debt markets, selling bonds due to mature in 2014, 2015 and 2016.

The implied cost of borrowing over two years fell from 4.71% to 2.80%; the three-year rate went from 5.09% to 3.68%; and the four-year borrowing cost fell from 5.97% to 4.60%.

On the secondary market, where government bonds already in circulation are traded by banks and other financial institutions, the yield on 10-year bonds fell below 6%. In recent months, yields had topped 7%, the level at which Ireland, Portugal and Greece had been forced to seek international bailouts.

The yield on Italian 10-year bonds also fell.

Investors in European companies also appeared upbeat about the plan. European stock markets closed up.

The FTSE 100 ended 2.1% higher; the German Dax, 2.9%; the French Cac 40 index, 3.1%; and the Spanish IBEX, 4.9% at the close.

Bank shares in particular rose sharply, as they stand to lose billions of euros should any eurozone government default on its debts as a consequence of the crisis.

French banks Credit Agricole and Societe Generale both closed up 8%, while in Germany, Deutsche Bank rose 7% and Commerzbank, 5%. In London, Lloyds banking group rose 7%.

Long-term financing

Responding to the plans, Peter Westaway, chief economist for Europe at asset manager Vanguard, said: "This is just the good news that was priced by the markets, and it has now been confirmed."

However, the euro fell back against the dollar to $1.2571 following its high of $1.265 reached before the ECB announcement.

"There is a long-term question of whether this will be enough to meet the long-term financing needs of Italy, and that probably remains."

Crisis jargon buster
Use the dropdown for easy-to-understand explanations of key financial terms:
AAA-rating
The best credit rating that can be given to a borrower's debts, indicating that the risk of borrowing defaulting is minuscule.

While Mr Draghi was announcing the ECB's plans, German Chancellor Angela Merkel was meeting Spanish Prime Minister Mariano Rajoy for talks on the eurozone crisis.

In a joint news conference afterwards, Mrs Merkel said: "We have to restore confidence in the euro as a whole, so that the international markets have confidence that member countries will fulfil their commitments."

Mr Rajoy said: "We want to dispel any doubts on the markets about the continuity of the euro."

Global risk

Jens Weidmann, president of Germany's Bundesbank, remains vigorously opposed to the ECB's plan, concerned that member states could become hooked on central bank aid and fail to reform their economies sufficiently.

But the majority of the 23 ECB council members support the plan.

And the Organization for Economic Co-operation and Development (OECD) added its support for the ECB bond-buying plan on Thursday, as it warned that the eurozone crisis posed the greatest risk to the global economy.

It is calling for more action from central banks to prevent a break-up of the eurozone.

"Concerns about the possibility of exit from the euro area are pushing up [government bond] yields, which in turn reinforces break-up fears," the OECD said in its global economic outlook.

"It is crucial to stem these exit fears. This could be achieved by the ECB undertaking bond market intervention to keep spreads within ranges justified by fundamentals."

In other eurozone news:

  • The central bank kept the benchmark eurozone interest rate unchanged at 0.75%.
  • The unemployment rate in Greece rose to 24.4% in June from a revised 23.5% in May, according to the Elstat statistics service. However, Spain remains the eurozone nation with the highest jobless rate, at 24.6% in June.
 

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  • rate this
    +31

    Comment number 211.

    If the Euro collapses then there will be some very large profits and losses made in the City. Should this happen then I am willing to go out on a limb and predict that the profits will mysteriously disappear before being taxed while the losses will, with a wave of the hand and a shrug of the shoulders, be added to the UK sovereign debt.

  • rate this
    +2

    Comment number 196.

    It's quite amazing how irational response to the existence of the Euro and banking institutions drives out rational consideration of what's actually happening.

    This is a VERY significant development. It's also VERY overdue. It means that the combined strength of the entire Eurozone will back up the smaller countries against the speculators.

    Maybe the beginning of the end of the crisis ...

  • rate this
    +21

    Comment number 164.

    All currencies will be in trouble and nothing will work until and unless voters (NOT politicians) realise that countries cannot spend more than it collects via taxes.
    Not many voters will vote for a political party that advocates going down this route and that equals trouble.

  • rate this
    -23

    Comment number 131.

    The euro is still there folks! Get used to it! UK eurosceptics and currency speculatotrs have failed to dislodge it now for 12 years. As with sterling and the dollar there will ups and downs along the way, but it's here to stay. Worry about sterling! It's small enough to attract speculators again and maybe soon.

  • rate this
    +26

    Comment number 100.

    Here we go again, yet another policy to save the Euro, two years of policies and funds that have done nothing. Its about time these politicians wake up and smell the coffee, the Euro has no future.

 

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