FRANKFURT (MNI) – European Central Bank Governing Council members
have offered more details on the government bond purchase program and
promised a fuller picture next week, although they will not disclose the
volume they intend to buy.

The central bank also warned of further potential trouble ahead as
Eurozone governments face increasing risks of refinancing problems as a
result of issuing more and more short-dated debt.

President Jean-Claude Trichet said Friday that the ECB will
“withdraw the liquidity that we will inject mainly through tendering
term deposits.”

Trichet did not specify potential supplementary draining methods
but assured that sterilizing the government bond purchases “does not
present technical difficulties.”

According to the central bank’s General Documentation these
fixed-term deposits are “envisaged only for fine-tuning purposes in
order to absorb liquidity in the market.”

The deposits accepted from counterparties are for a fixed term and
with a fixed rate of interest and the central bank does not give any
collateral in exchange for the deposits, the documentation says.

Neither the frequency with which deposits are collected nor the
maturity of the deposits are standardized and the Eurosystem has the
option of restricting the operations to limited number of
counterparties.

Earlier this week, ECB chief economist Juergen Stark said that the
central banks would hold all government bonds until maturity.

Full details for the plan to sterilize bond purchases will be
released next week, Executive Board member Jose Manuel Gonzalez-Paramo
promised. He also said that the ECB would not disclose the total volume
of the bond buying program.

While the ECB’s bond purchase program is currently propping up
government debt in international markets, the central bank warned that
an increasing reliance on short-term debt may create fresh refinancing
problems.

According to the ECB’s Monthly Bulletin, between mid-2008 and
mid-2009, the share of new borrowing with a maturity of less than one
year doubled to 12%.

“While potentially reducing governments’ current borrowing costs,
increased reliance on short-term borrowing exposes governments to
greater refinancing risk, which, if taken beyond a certain level, may
not be in the broader interests of macroeconomic and financial
stability,” the ECB said.

“The larger the stock of short-term and variable interest rate
debt, the higher the sensitivity of government interest expenditure with
respect to changes in monetary policy rates,” it added. Should the
policy cycle eventually turn, governments may thus face troubles
refinancing under affordable conditions.

In line with this warning, a number of policy makers reiterated
that Eurozone government must consolidate and exercise fiscal prudence.

Trichet and Executive Board member Lorenzo Bini-Smaghi also offered
a bright side to the tough situation the Eurozone is currently facing.
While the EMU governments face tougher fiscal adjustment pressures now,
this might help them to emerge faster and stronger than other
industrialized countries from the current crisis, they argued.

Bini Smaghi suggested that markets may be mistaken in believing
that in countries where “there is a perfect overlap between the monetary
and fiscal authorities the risk of insolvency” is smaller than in the
Eurozone, “which cannot monetize its debt.”

“If the euro area is able to overcome the current difficulties and
restore its public finances in time, it will exit from this ‘public’
phase of the crisis before others,” he said.

Trichet said that “it is a complete fallacy to say that fiscal
soundness dampens growth. It is exactly the contrary. It is the absence
of fiscal credibility which dampens growth,” he said.

Trichet reiterated that we “certainly do need change in Europe –
fundamental change.”

—
May 10, 2010:

FRANKFURT (MNI) – Whether or not the European Central Bank’s
decision to buy government bonds proves a turning point in the sovereign
debt crisis, it is certainly a turning point for the central bank
itself.

The decision, announced in conjunction with a reopening of
liquidity operations and forex swap lines as well as a E750 billion
stabilization fund provided by governments and the IMF, has sent spreads
lower, halted the recent rise of Euribor rates and pulled up the
foundering euro.

The positive impact should prove longer-lived than the short
reprieves after previous rescue announcements, given the massive size of
a program that underscores what Eurozone leaders call their
determination to “use the full range of means available to ensure the
stability of the euro area.”

The ECB’s decision to subscribe to this commitment — even at the
price of betraying some of its core principles — may however have
damaging long-term implications.

By choosing the so-called nuclear option, the ECB is rocking its
own foundations by directly monetizing of excessive fiscal deficits and
exposing itself to political pressure impugning its independence.

ECB Executive Board member Juergen Stark warned late last year that
any government bond purchases “would amount to the monetization of
government debts — a sure road towards inflation over the medium term,
with adverse effects on our independence and credibility.”

Nor did Axel Weber hesitate to violate Trichet’s single-voice rule
to express his objections after the fact: “The purchase of government
bonds carries significant stability risks, and that is why I view this
part of the ECB’s Governing Council’s decision critically even in this
extraordinary situation,” he said Monday.

The ECB’s chief economist may well be have been right and the
Bundesbank president’s concerns justified.

The central bank said that governments’ promises to intensify
budget consolidation efforts and meet strict deficit targets justified
its decision. However, the current crisis is the best example that, even
if enshrined in law, such promises mean little.

In the meantime, the ECB will carry on its balance sheets the risk
of default of weak economies. Losses would be born by national central
banks and the borrowing government would be off the hook.

The ECB also assured that the program will not affect its monetary
stance, thus limiting inflation dangers, since it will sterilize
interventions with “specific operations” to re-absorb the liquidity
injected through the Securities Markets Programme.

At the same time, however, the ECB has reactivated some of the
longer-term unlimited liquidity-providing operations it had previously
phased out. Depending on banks’ bidding behaviour, this may lead to an
expansion of the monetary base and higher inflationary pressures down
the road.

Inflation expectations may also become unanchored after the ECB
set a precedent last night by showing its willingness to sacrifice key
principles. If the ECB can buy government bonds, some could rightly
wonder, might it not also one day turn a blind eye to risks that
inflation could exceed price stability targets?

Credibility concerns are all the more pressing as the decision
cannot necessarily be read as a measure of last resort, since the
stabilization fund of Eurozone governments, the European Commission and
the IMF alone might well have been enough to calm markets. At E750
billion, the program would cover almost all funding requirements of
periphery countries until end-2011. Together, Italy, Portugal, Spain and
Ireland are estimated to need some E900 billion.

Admittedly, the central bank’s response is a lot quicker —
national central banks already confirmed that they have begun buying
bonds. However, the stabilization mechanism by itself might have been
powerful enough to prevent the collapse of the Eurozone.

During the financial crisis the ECB has shown more flexibility than
its critics might have envisaged. In the current sovereign debt crisis
may be showing too much.

Much of the sovereign debt program — its scope and the
sterilization methods — remain unknown. Regardless of the details,
today certainly marks a turning-point for the central bank, showing it
is much more flexible on key principles than its founding fathers’ had
ever wanted it would be.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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