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October 30, 2012 4:27 pm
In the two-month phoney war since the European Central Bank announced its controversial bond-buying plan, the most likely candidate, Spain, has not blinked and asked for help and the bank has not shifted in its refusal to discuss terms with Madrid.
Yet the borrowing costs of Spain, Italy and other countries with distressed bond markets have fallen, raising the tantalising prospect that the ECB may have won its battle to eliminate eurozone break-up speculation without buying a single bond.
No one has declared victory and Mario Draghi, ECB president, and the bank are still stressing the readiness of the scheme, called outright monetary transactions, or OMT, for deployment, while refusing to be drawn into discussions about the bond yield levels at which they would intervene.
Instead, they have repeatedly stressed the fiscal conditions that would come with any OMT programme and their steely resolve to suspend any bond-buying programme at the first hint of a country straying from its agreed path.
The risk that such a course of action would send bond yields spiralling higher again, with possibly drastic consequences, has fed fears that the ECB would fail to carry out the threat and instead find itself “damned to print money” as one critic put it. Privately, the ECB portrays the reality of stop-start bond buying as less dramatic, with the suspension of OMT likened to withdrawing a carrot rather than applying a stick.
Germany’s Bundesbank sees OMT as tantamount to printing banknotes and Jens Weidmann, its president, voted against it at the meeting of the interest rate-setting governing council that launched OMT in early September.
Suspension of the bond buying even during review periods was a concession designed to win the wavering votes of council members from the Netherlands and Finland.
Mr Draghi this week again sought to underline the bank’s resolve to stick to that pledge in an interview with the German weekly Der Spiegel, part of a charm offensive to sway German public opinion to the OMT programme during which he also subjected himself to questions from members of the Bundestag last week.
“If a country does not adhere to what has been agreed, we will not resume the programme,” he told Der Spiegel. “We have announced that we will suspend operations once a programme country is under review. We will then ask the International Monetary Fund and the European Commission to assess whether the country is keeping the conditions of the agreement, and only after a positive assessment will we resume operations.”
One ECB official said such a suspension of bond buying was “not a life and death issue”, unlike, say, the provision of central bank liquidity to Greek banks. “They can live with high interest rates for some time.”
The lull in the crisis and falling borrowing costs of Spain, thanks in large part to the existence on paper of OMT, has allowed Mariano Rajoy, prime minister, to hold off from applying for a credit line to the European Stability Mechanism, an EU rescue fund. That is a necessary first step towards an OMT programme, which Spanish business leaders have been lobbying him to make use of.
The ECB will internally define a “backstop” or level of bond yield for any given country under OMT that it believes is appropriate, but will not publish it, although it acknowledges markets are likely to gauge where it lies. It will hold any bonds bought in its trading portfolio, so they can be sold, and wants to have the flexibility of being able to adjust the level of the backstop without giving too many details.
Officials acknowledge that defining that level is not straightforward. “We don’t have a single model in a safe with a single formula,” said one. “There is an element of judgment.”
The justification for undertaking OMT presented by the ECB is that financial markets had started pricing in the risk of a eurozone break-up in the bond yields of some countries.
OMT is meant to tackle solely this “redenomination risk” that is preventing the ECB’s standard monetary policy operations affecting the borrowing costs of companies in Spain and Italy, rather than seeking to iron out all differences in borrowing costs between them and countries such as Germany where rates are considerably lower.
With some influential voices already saying the “redenomination risk” has for now been eliminated, it is quite possible that Spain could trigger the conditions for OMT without the ECB actually then deciding to buy any bonds, further complicating Mr Rajoy’s deliberations over when to take the plunge.
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