ECB Update: ECB Has ‘No Taboos’ As Crisis Reaches New Height
FRANKFURT (MNI)- European Central Bank President Mario Draghi said
over the weekend that the central bank had no policy taboos in its fight
against the debt crisis, suggesting that if the crisis escalates
further, the Eurotower may act before the start of the forth quarter.
The deepening of the crisis may well require some additional
flexibility by the central bank. On Monday, Spanish borrowing costs
hit a new euro-era high as fears about the country’s ailing economy and
the possible need for a full-blown bailout outweighed the Eurozone’s
green light of Spanish bank recapitalization aid. Italian borrowing cost
moved in tandem.
Adding to market jitters are new concerns over a possible Greek
exit from the Eurozone. According to German media reports over the
weekend, the International Monetary Fund and some key Eurozone
governments, including Germany, have signalled they will not contribute
to any further financial aid to Greece.
Inspectors from the troika – the European Commission, the ECB and
the IMF – will arrive in Athens this week to assess progress of Greece’s
commitments under the aid program. An unfavorable assessment coupled
with a creditors’ refusal to step up support could push Greece into
default in September.
Draghi told French newspaper Le Monde that the ECB had “no taboos”
when it comes to policy tools. Importantly, the comment came as a
response to a question about IMF policy advice in which the fund called
for more rate cuts and argued strongly for fresh bond purchases – either
under a qualitative easing program or a stepped-up version of the ECB’s
Securities Market Program.
“We are very open and have no taboos,” Draghi told the paper. “We
decided to lower interest rates below 1% because we expected that
inflation would be close to or below 2% at the start of 2013. Now it is
probable that it will come down by the end of 2012.” The explicit
reference to faster than expected inflation decline – even compared to
the last policy assessment – suggests that Draghi sees further room on
interest rates possibly even in the near term.
But rather than interest rate cuts, “taboos” likely referred to the
option of government bond market interventions. “The ECB could achieve
further monetary easing through a transparent QE program encompassing
sizable sovereign bond purchases, possibly pre-announced over a given
period of time,” the IMF suggested. It raised the option of reactivating
the ECB’s dormant government bond buying program.
While the ECB has thus far put up strong resistance against buying
government bonds on a large scale, this may change if the interest rate
tool is fully exhausted and the economy fails to stabilize.
The ECB has put forth two key arguments against bond market
interventions. Firstly, in the Eurozone, banks play the dominant role in
financing the economy and efforts should therefore be concentrated on
the banking sector rather than the bond market. Secondly, it has
stressed that the Maastricht Treaty prohibits it from financing
The negative feedback loop between banks and weak sovereigns has
shown that supporting banks may indeed require bond market intervention,
undercutting the first argument. On the second, nothing prevents the ECB
from buying government debt on secondary markets so long as it is deemed
as necessary to conduct monetary policy. Should deflationary pressures
emerge when the ECB has exhausted its interest rate tool, the central
bank is free and, arguably, obliged to act to ensure price stability.
“Our mandate is to maintain price stability in order to prevent
both higher inflation and a generalized, broadly based fall in prices.
If we see such risks of deflation, we will act,” Draghi told Le Monde.
Later in the interview Draghi stressed that the ECB has “to maintain
price stability in both directions” and must “act without prejudice.”
Any large scale government bond market intervention, while not a
taboo, will likely require the central bank to see risks of deflation in
the Eurozone. This is currently not the case. A possible Greek exit from
the Eurozone after September’s decision over the next bailout tranche
could prove a tipping point where the ECB identifies deflation threats
stemming from weak growth coupled with contagion risks. That could
clear the path for bond market intervention.
–Frankfurt newsroom +49 69 72 01 42; e-mail: email@example.com