Draghi Announced Unlimited Bond Purchases by the ECB

on Sep 14, 2012
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Last week Mario Draghi, president of the European Central Bank (ECB), announced a new bond-buying plan meant to ease the Eurozone’s debt crisis. The bank could potentially buy unlimited amount of sovereign debt with maturities of between one and three years.

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Mr Draghi proved he is not backing down from his July pledge to do whatever is necessary to preserve the euro. He assured the purchases of the Eurozone countries’ sovereign debt will be conditional on governments signing up to a European Stability Mechanism programme or to a European Financial Stability Facility. “Under appropriate conditions, we will have a fully effective backstop to prevent potentially destructive scenarios,” Draghi told a news conference.

To offset investors’ concern about being paid last in the event of a sovereign default, Mr Draghi said the ECB is willing to waive its senior creditor status on the bonds it purchased. This means the bank will be treated equally with the private creditors. The liquidity created in the system via the bond purchases will also be “fully sterilised” in order to counter inflation – banks will be called on to park funds at the ECB, on which they will receive interest.

!m[](/uploads/story/361/thumbs/title_pic_inline.png)The bond-buying plan was overwhelmingly approved by ECB’s governing council despite opposition from Bundesbank representative Jens Weidmann. With his No vote, Mr Weidmann isolated himself from his peers in the governing council but received strong support in Germany for his decision to fight against the huge fiscal transfers expected to further burden taxpayers. According to the Bundesbank representative “The announced interventions carry the additional danger that the central bank may ultimately redistribute considerable risks among various countries’ taxpayers.” The German central bank “regards such purchases as being tantamount to financing governments by printing banknotes”.

The German finance minister Wolfgang Schaeuble did not outright oppose the ECB’s proposed plan but insisted that countries need to press on with cutting their deficits and reforming their economies. They should not interpret the bond buying as a green light to relax their efforts in strengthening their balance sheets. “It would be a serious mistake if the ECB decision were misinterpreted in the sense that we could now let up on our efforts. The opposite is the case.” he opined for Germany’s Buld am Sonntag newspaper.

Mr Draghi announcement was met cheerfully by investors around the world. On Thursday, the yield on Spanish 10-year bonds fell 35 basis points to its lowest levels in six months, while Italian 10-year yields fell 15 basis points to the lowest in four months. The S&P index rose 1 percent just a few points short from a year high. Eurozone blue chip stocks soared 3.2 percent to levels not seen since March. The only disappointment came from commodity prices, which were buoyed by the ECB announcements. Crude oil rose by $1.50 (£0.94) on Thursday to $144.59 (£90.4) a barrel and wheat rose 8 cents (£0.05) a bushel to $8.54 (£5.34).
Two looming threats could potentially ruin Brussels’ efforts to rescue the Eurozone – the German constitutional court ruling and the Dutch elections. The outcomes of both are expected to become apparent on Wednesday.
In the beginning of August a lawsuit was filed in the German constitutional court which challenged the European Stability Mechanism, the Eurozone’s permanent $500 billion rescue fund. The lawsuit could delay creation of the ESM and virtually halt any bond-purchasing plans, wreaking havoc in the Eurozone.
The other growing concern in August were Dutch elections, which were expected to produce a more eurosceptic government in a key creditor country of the Eurozone, limiting the flexibility of institutions to address the crisis. Recent polls however showed the Labour party is now trailing behind the pro-EU Liberals by one percentage point, after a number of vibrant debate performances by the Liberals’ party leader – Diederick Samsom and a barrage of strong US-style campaign ads. Mr Samson’s comeback will most probably produce a centrist coalition between the Labour and the Liberal parties, which would be considerably more pro-European compared to the current conservative government.

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