The Euro rose on Wednesday after media reports suggested that the ECB may buy unlimited amounts of short-term government debt to ease the region’s financial crisis. A report from Bloomberg today that suggested the purchases of the debt of some Eurozone countries could be unlimited dispelled some recent skepticism about the scale of the program. European Central Bank President Mario Draghi’s bond-buying proposal involves unlimited purchases of government debt that will be sterilized to assuage concerns about printing money, two central bank officials briefed on the plan said.
Under the blueprint, which may be called “Monetary Outright Transactions,” the ECB would refrain from setting a public cap on yields, according to the people, and a third official, who spoke on condition of anonymity. The plan will only focus on government bonds rather than a broader range of assets and will target short-dated maturities of up to about three years, reported Bloomberg. The euro jumped half a cent on the report to $1.2596 and European stocks advanced. An ECB spokesman referred to an Aug. 20 statement in which the Frankfurt-based central bank said it was misleading to report on decisions that haven’t been taken yet. The ECB may also be ready to waive seniority status on government bonds it buys under the new program, which would mean investors would not rank lower in any restructuring of Eurozone Sovereign Debt, making the bonds more attractive to private investors.
After having said that, now the markets want to hear details of the policy. But internal ECB tensions, fuelled by Bundesbank resistance to bond-buying, and the ECB’s eagerness to retain an element of surprise mean it will reveal only a partial outline on Thursday. Draghi told the European Parliament this week that the ECB needs to intervene in bond markets to wrest back control of interest rates in the fragmented Euro-area economy and ensure the survival of the common currency. Policy makers will start deliberating on the plan later today and Draghi will announce whether it has been agreed to at a press conference tomorrow.
“For the moment, the focus really is on the word ‘unlimited,’ which, if indeed affirmed by Draghi at tomorrow’s meeting, would constitute a new step in the ECB’s rhetoric,” said Thomas Costerg, an economist at Standard Chartered Bank in London. That would “send a powerful signal to the market.”
The report on Draghi’s bond plan prompted currency, equity and bond markets to rally. The officials said policy makers are likely to adopt the proposal, with Germany’s Bundesbank remaining the sole objector. At the same time, one said Draghi’s relationship with Bundesbank President Jens Weidmann remains relaxed, and the two men only disagree on whether risks inherent in the bond plan are likely to materialize.
To sterilize the bond purchases, the ECB will remove from the system elsewhere the same amount of money it spends, ensuring the program has a neutral impact on the money supply. With the central bank’s deposit rate at zero and the Eurozone banking system currently awash in about 800 billion euros ($1 trillion) of excess liquidity, a larger bond program may not present the ECB with a major obstacle.
While the ECB doesn’t expect to have to spend large sums of money on bonds, Draghi’s plan calls for no limits to be set, two of the officials said. The ECB also won’t have seniority on any bonds it buys, they said. No yield-spread targets or bands will be set publicly, they said. Two said targets won’t be set internally either and that interventions will be discretionary.
Draghi will stress conditionality of the program tomorrow, with the ECB likely to stop buying the bonds of any government that fails to meet the conditions it agrees to when it signs up for aid from Europe’s rescue fund, a precondition for ECB action, two of the people said. Another proposal is for the ECB to sell the bonds it has bought if a country doesn’t comply with the conditions, two of the officials said.
“They are likely to announce unlimited bond buying which sounds good, but there will conditionality attached which will keep the Eurozone members from signing up to it,” said Michael Woolfolk, senior currency strategist at BNY Mellon in New York. Investors are on tenterhooks after brinkmanship in the ECB’s internal negotiations over the plan was played out in public last week, with one newspaper reporting that Bundesbank chief Jens Weidmann even considered quitting. The ECB is being forced to take a greater role in fighting the debt crisis while governments negotiate legal and political hurdles to coordinating a longer-term response, but Germany’s Bundesbank wants to limit the scope of ECB action.
Spanish and Italian government bond yields fell on Tuesday as investors welcomed leaked comments made by Draghi behind closed doors in the European Parliament on Monday, when he suggested the ECB could buy bonds with a maturity of up to three years – at the long end of market expectations. The growing likelihood of ECB action to ease stresses in the European debt market had curtailed demand for safe-haven German bonds at an auction of new 10-year paper earlier in the day. The German Finance Agency, which managed the debt sale, only received bids from investors worth 3.93 billion euros ($4.9 billion) for the 5 billion of bonds it wanted to sell.
The Bundesbank vehemently opposes government bond purchases, saying they come close to breaching the taboo of central bank financing of governments, and its criticism has not let up. Its previous head, Axel Weber, resigned in opposition to a previous bout of bond-buying by the ECB. Disagreements within the policy-setting Governing Council may keep the ECB from giving too many specifics. The ECB also wants to keep markets guessing about its bond-buying moves to discourage speculators and maintain pressure on governments to pursue economic reforms and fiscal discipline. Even in the absence of inflationary pressures, the ECB must show its primary focus is still on guarding price stability.
Sources have told Reuters the ECB has considered setting interest rate bands – rather than a specific cap – as internal guideline for intervention, but it would not publicly declare any target for yields or spreads that would force it to enter the market when the barrier was exceeded. Draghi said after the ECB’s August 2 meeting that the bond buying would focus on the short end of the yield curve. His suggestion on Monday that this could mean maturities of up to three years was positive for markets as the longer the maturities the ECB targets, the more bonds it could buy. “If we are in the short-term part of the market where bonds have a length of time maturity of up to one year, two years, or even three years, these bonds will easily expire,” Draghi told a European Parliament committee.
Weidmann’s reported threat to resign, though not confirmed, has piled pressure on Draghi to mollify opponents of the plan without tying it up in so many knots it is rendered ineffective. One way to placate the Bundesbank could be to insist that the International Monetary Fund – seen as tougher than European Union institutions – is involved in setting conditions for future bailouts, and hence for bond buying, as suggested by ECB policymaker Joerg Asmussen.
While the bond-buying plan will be the main focus of Thursday’s meeting, there is a chance the ECB will also cut interest rates from 0.75%, already a record low, due to a deepening slowdown in the Eurozone economy. Whether a rate cut comes may depend on how many details of the bond program the ECB can present. ECB may probably disappoint at least marginally on the intervention part, so to compensate for the lack of details on the bond-buying part, it could also be inclined to cut rates.
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