You know we’re in the midst of summer silly season when thinly traded markets can lurch from abject worry to giddy euphoria merely because European Central Bank chief Mario Draghi insists he will do everything in his power to safeguard the euro and essentially warns investors not to underestimate his ability to do so.
Mr. Draghi has made similar statements before, to much less fanfare or market reaction. The only surprise is that he and his bank haven’t been more forceful throughout the euro-zone debacle. After all, if the currency union breaks apart, the ECB will have no reason to exist and the MIT-trained economist will be out of his high-powered job.
“I’m still astonished that we haven’t seen more aggressive monetary policy action from the ECB, except in a reactionary mode,” says Brian Bethune, president of Alpha Macroeconomic Foresights in Wenham, Mass., and a long-time advocate of bold central bank intervention to arrest the crisis.
“The only sensible way out of this is for maximum thrust on monetary policy. European short-term rates should be at zero, which is where they are in the U.S. … These are situations that call for really bold action, not dancing on the head of a pin.”
In more normal times, a central banker vowing to defend his currency would be a signal to panic. After all, the ECB has insisted this long-running crisis can only be resolved at the political level, through region-wide fiscal and market reforms. For the most part, under strong Germanic influence, bank policy-makers have sat on their hands as economies have veered off a cliff and Spanish and Italian bond yields have ballooned, rendering the bank’s interest-rate weapon useless.
But this time investors choose to believe that real action may actually follow brave words, as the Europeans must surely realize they are now standing at the edge of the abyss. And despite the naysaying of skeptical analysts, the market may be right.
First, there was the venue chosen for Mr. Draghi’s seemingly impromptu remarks: an otherwise unremarkable investment conference in London, bursting with news media from around the world gathered for the Olympics.
Then, there was the timing: just a week before the bank’s crucial policy-setting meeting this Thursday and a day after a key member of the ECB’s governing council mused publicly about a banking licence for Europe’s rescue fund, so it could legally tap the central bank for unlimited financing.
On Friday, German Chancellor Angela Merkel and French President François Hollande, the political leaders with the biggest say in the euro’s future, predictably pledged their undying devotion to the 17-nation currency union. But they also encouraged a more activist role for the central bank.
Mr. Draghi signalled just such an intention with his pointed reference to the fact widening yields on sovereign debt undermine the efforts of the central bank to keep interest rates low at a time when several economies have skidded back into recession. As a result, he declared, “they come within our mandate.”
This is the clearest signal yet that the ECB has devised a legitimate reason to get back into the bond-buying game, snapping up troubled countries’ bonds to bring down rates. German Finance Minister Wolfgang Schaeuble, Ms. Merkel’s hatchet man in the crisis, declared it was a good thing that “the ECB will grasp the necessary measures within its existing mandate to secure the euro.”
Shortly after my conversation with Mr. Bethune at a Toronto bistro, news reports out of Europe indicated the ECB and European governments were hatching a plan for the bank to join the existing European rescue fund in acquiring Spanish and Italian debt. The fund would take care of the primary market and the ECB would restart a program to buy up bonds on the secondary market. The combined defence would stabilize yields and buy more time for the fiscally battered governments in Madrid and Rome.
That didn’t prevent those party-poopers at the Bundesbank from attempting to pour cold water on any big-time quantitative easing plans. Germany’s central bank said it remains opposed to both bond purchases and any ECB financing of the permanent rescue fund, which still awaits approval.
Because of the profound impact of the euro crisis on other economies and markets, all eyes will be on Mr. Draghi and his bank heading into the policy meeting. Another rate cut is all but assured. And with Ms. Merkel in his corner, it seems likely Mr. Draghi will face down opposition to his bond strategy.
But we’ll know more after he sits down for what could be a tense chat with the Bundesbank’s tough chief and fellow council member Jens Weidmann before the policy meeting. It’s worth noting that two senior German officials angrily quit the ECB over its previous bond purchases, which were suspended in March.
If the Draghi plan ends up being watered down, we could see a quick return to fear and fury in the markets and a replay of last August’s scary stampede to the exits.
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