IN LATE July Mario Draghi, president of the European Central Bank (ECB) promised the bank would do “whatever it takes” to ensure the euro’s survival. His reassuring words helped to ensure that August passed without financial markets suffering a panic attack during the holiday season.
Yesterday, Mr Draghi was required to deliver: to add substance to his promise, and to outline the actual steps the ECB would take to prevent a collapse of the euro zone. He did not disappoint the public or, for now, the markets. Yesterday the euro rallied strongly after the ECB meeting and bond prices in Italy and Spain rose.
Once again the president made clear the ECB was willing to buy the sovereign bonds of peripheral eurozone countries in difficulty. The bond buying would be done without limits, but subject to strict conditions; terms that countries seeking central bank support must first accept. Mr Draghi’s great coup lay in securing near-unanimous backing from members of the ECB’s governing council for his approach – the Bundesbank’s Jens Weidmann was the sole dissenting voice.
Could he have gone further and been more precise? Mr Draghi was conscious the German constitutional court will decide next week on the legality of the European Stability Mechanism (ESM) bailout fund. Clearly, he was anxious not to upset German public opinion, which remains deeply divided on the merits of any ECB intervention in bond markets. The president set out in some detail the ECB’s proposals to resume its bond buying programme to help lower the borrowing costs of euro area countries in particular difficulty. Throughout yesterday’s press conference Mr Draghi constantly sought to reassure his critics on two issues: first, that the ECB was neither exceeding its legal mandate in buying up short-term debt in the secondary market under strict conditions, nor was it ignoring its primary objective – to maintain price stability in the euro zone and so keep inflation in check.
The ECB clearly hopes that this bold initiative will mark a turning point in the euro zone crisis. Bond markets in the euro area are – as Mr Draghi said yesterday – distorted, and are pricing in the collapse of the single currency. That distortion can be seen and best measured in the form of capital flight from the euro zone periphery to the relative safe haven of German sovereign debt. This has produced negative returns for investors, and record low borrowing costs for Germany.
When the ECB, from 2010 to earlier this year, spent €210 billion buying sovereign bonds on the secondary market, it made little difference. Then the ECB’s intervention was temporary, its bond buying was limited, and no conditions were set for the purchase of distressed euro zone debt. Financial markets remained unimpressed. This time is different. The proposed ECB intervention is indefinite; the purchase of government debt is unlimited. But only those governments that are committed to fiscal reforms and willing to accept the conditions of support, can access it. Mr Draghi has delivered. The onus is now on others, notably Spain, to respond.