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The ecb's new bond purchase programme

The Economist, Sep 6th 2012, 15:23 by G.I. | WASHINGTON

SINCE the euro crisis erupted, the European Central Bank has been torn between its legal and philosophical aversion to financing governments and its duty as lender of last resort. Today, it appears to have reconciled the two, erring on the side of the latter.

At the end of its governing council meeting today, the ECB announced the much-anticipated details of how it would resume intervening in the region’s government bond markets. Using its newly christened Outright Monetary Transactions, it will buy sovereign bonds of one- to three-year maturity, provided the issuing country has agreed to a fiscal adjustment programme with either the European Financial Stability Facility, or its successor, the European Stability Mechanism.

Mario Draghi, the ECB president justified the programme as a necessary adjunct to monetary policy, because the ECB’s ability to set interest rates for the euro zone as a whole has broken down over fears that some countries may leave the single currency. He never used the words "lender of last resort", a role the ECB readily accepts for banks but not for governments. Nonetheless, that is the de facto purpose. The purchases will act as “an effective back stop to remove tail risks from the euro area,” Mr Draghi told reporters. “Bond markets are distorted ... in all directions.” The new purchases will restore “monetary policy transmission and recreate the singleness of the monetary area.”

The broad outlines were as expected, and the underlying details were reassuring.

First, the ECB laid out two ways countries' bonds would qualify for ECB buying: if the country enters a full macroeconomic adjustment programme, as Portugal, Greece and Ireland have; or a less stringent “precautionary programme,” essentially a line of credit to countries with sound policies experiencing temporary shocks. This is important: the latter offers Spain and Italy a less treacherous way to access the ECB’s balance sheet.

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Not too little, possibly too late

The Economist, Sep 6th 2012/ Print edition

Second, the ECB made clear OMT purchases were, theoretically, unlimited, ie they have no “ex ante quantitative limits". Mr Draghi said they would end when the goals are achieved or the recipient countries stop complying with their conditions.

The ECB had always insisted purchases under its previous Securities Market Programme, (SMP) were temporary. The effect on yields was thus fleeting; investors could not be sure that Europe could or would commit the money necessary to meet the potentially enormous financing needs of every country at risk. Since the ECB can simply print the money it uses to buy bonds, its resources are theoretically unlimited. (It will "sterilize" the impact of its bond purchases on the money supply, but that should pose no constraint on how much it buys.)

Third, the ECB will not insist on senior credit status; it will rank “pari passu” with other holders of the same bonds, meaning in the event of a default it will not insist on being paid in full ahead of others. Without that proviso, official intervention threatened to accelerate the flight of private capital. Mr Draghi noted, however, that this did not apply to the bonds previously purchased under the SMP.

The one major omission was detailed criteria under which the ECB would intervene. There will be no explicit cap on yields or spreads. Mr Draghi said the ECB will examine a variety of indicators, including yield levels, yield spreads, credit default swaps, liquidity conditions, and volatility.

This is good enough, for now. Yields on Spain’s 10-year government bonds dropped to 6.09% from 6.41% on Wednesday; on Italy's, to 5.36% from 5.51%. Stockmarkets rallied. Neither Italy nor Spain have yet said they would seek aid, preferring to await the details of the ECB's programme. Barclays said it expects Spain to sign a memorandum of understanding with the European finance ministers in early October, while Ireland could actually qualify even sooner, assuming it regains access to the bond market.

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