ANALYSIS:Draghi tightened euro zone suspense with talk of a return to bond markets – but not yet and not as before

WILL HE or won’t he? Analysts, journalists and politicians had a week to chew over a promise from European Central Bank president Mario Draghi in London to do “whatever it takes” within the bank’s mandate to stabilise the euro.

“And believe me, it will be enough,” he added for emphasis.

Analysts assumed the ECB president was hinting at a looming revival of bond-buying to cut borrowing costs for crisis-hit Spain and Italy. Spreads eased as markets watched and waited.

Arriving for his press conference after yesterday’s governing council meeting, Draghi was aware expectations were high. The ECB was, he conceded to journalists, “entering unchartered waters”.

Then he showed his hand: the ECB ship was mulling a return to bond markets, just not yet and not as in the past. The bank president reminded his audience in Frankfurt, and around the world, that his job was to manage the euro zone’s currency, not anyone else’s expectations.

The ECB, he said, “doesn’t act under terror but under a normal, cool analysis of the facts”.

While the facts are clear – Spain and Italy’s unsustainable borrowing costs as proof of the widening euro zone crisis – how to address these facts has left Draghi walking a high wire.

On the one hand, he had to show Frankfurt takes seriously what he called “malfunctioning markets” and an “ominous” rise in some sovereign debt.

On the other hand, a simple reactivation of bond-buying would divide the ECB governing council further and risk damaging the bank’s long-term credibility.

And so he stalled, presenting three messages.

To the markets: the ECB will take its time to come up with a new instrument for bond-buying on secondary markets that “falls squarely within our mandate” and does not breach the ban on state monetary financing. Any such instrument, he said, will be large enough to achieve its main aim – lower borrowing rates – while taking into account concerns of private investors over their own senior creditor status. The timing of the new instrument’s activation is unclear, but it is likely to be used to buy shorter-term bonds to allay fears of northern euro zone members of being burdened with southern European debt for years.

His second message, to crisis-hit countries like Spain and Italy, was loud and clear: if you want us to help drive down your interest rates, apply for a bailout.

His final message, to euro zone leaders, was similarly blunt: you first. “Governments must stand ready to activate the EFSF/ESM in the bond market when . . . risks to financial stability exist – with strict and effective conditionality,” he said. With that, the ECB president confirmed speculation of recent days that the Frankfurt bank is ready, in principle at least, to act on secondary markets if the euro zone bailout funds intervene on primary markets.

He acknowledged continued concerns around the 23-seat governing council table about the path ahead, particularly from Bundesbank president Jens Weidmann.

Germany, along with allies from the Netherlands to Finland, believe that bond-buying to reduce punitive interest rates on sovereign bonds would disincentivise crisis countries to reform and brings risks of inflation and diminished ECB credibility. “The endorsement to do whatever it takes to preserve the euro as a stable currency unanimous,” said Draghi yesterday, “but it is clear and it is known that . . . Mr Weidmann and the Bundesbank . . . have reservations on buying bonds.”

As the press conference wore on, Draghi swatted away suggestions of a discrepancy between his words in London and yesterday’s deeds in Frankfurt.

“We are not rowing back,” he said, pointing out the speech made no reference to timing or bond-buying but, instead, contained explicit references to the limitations of the ECB mandate. “The stance behind that speech was an affirmation that a euro zone area is a strong place in the world and euro is a strong currency and is irreversible . . . market expectations are what they are.”

But markets weren’t the only ones who hurried to react last week. Statements by holidaying French, German and Italian leaders that they, too, would do whatever it takes to back the euro, drove on speculation that a twin-pronged ECB/EFSF market intervention was on the cards.

Even as Draghi was speaking yesterday, journalists in the ECB press room watched on their laptops as markets were seized by a familiar sinking feeling.

Analysts were divided: was the ECB kicking the can down the road or, in a nod to crisis reality, announcing a shift in Frankfurt thinking? The initial reaction was negative: euro rises in early trading were reversed, as were recent falls in Spanish bond yields.

Draghi may have bought some time for the ECB but divisions remain and financial pressure on Spain and Italy is on the rise.