The European Central Bank’s bond-buying program has bought Spain and Italy time to stabilize their finances.
But if they drag their heels, the market will sniff them out. It will then be almost impossible to come up with another plan to rescue the euro zone’s two large problem children and, with them, the euro.
The promise in late July by Mario Draghi , president of the European Central Bank, to “do whatever it takes to preserve the euro zone” has already had a notable effect on borrowing costs for Madrid and Rome.
Ten-year bond yields, which peaked at 7.6 percent and 6.6 percent, respectively, a few days before Mr. Draghi made those comments, collapsed to 5.7 percent and 5.1 percent Friday .
Most of the decline came before Mr. Draghi spelled out Thursday the details of how the bond-buying plan would work .
What makes the program powerful is that the E.C.B. has not set a cap on the amount of sovereign bonds it will buy in the market.
The central bank’s financial firepower is theoretically unlimited, whereas the euro zone’s own bailout funds do not have enough money to rescue both Spain and Italy. But the new type of intervention has three important limitations.
First, the E.C.B. will only buy a country’s bonds if its government agrees to a bailout program with the euro zone and sticks to “strict and effective” conditions detailed in such a deal. Second, the central bank will focus its purchases on bonds with a maturity of one to three years.
Finally, Mr. Draghi has not specified how much he wants to drive down the borrowing costs for Madrid and Rome.
This fine print makes sense. But it also means that there is no free lunch. While the E.C.B. is unlikely to dream up new economic changes for Spain and Italy, it will probably want those countries’ governments to put more precise time frames around what they are already supposed to be doing.
The involvement of the International Monetary Fund, which has a somewhat unfounded reputation as a bogeyman, will also be sought. No wonder neither Prime Minister Mariano Rajoy of Spain nor Prime Minister Mario Monti of Italy is rushing to take advantage of the plan.
Meanwhile, the E.C.B.’s focus on short-term bonds means Spain and Italy will have to find some other way of issuing long-term debt, which accounts for 66 percent and 62 percent of outstanding debt, respectively.
If they lose access to the markets, the zone’s bailout funds would have to ride to the rescue. But the zone still would not have enough money for both countries. What is more, Spanish and Italian borrowing costs are still too high for comfort.
The E.C.B.’s main justification for buying bonds is that investors are unfairly punishing them because of fears that the euro zone will break up. But it also recognizes that the spread between their bond yields and the German 10-year borrowing cost of 1.5 percent is only partly due to such “convertibility risk.”
It is also attributed to bad economic policies. Although there are no scientific measures of convertibility risk, it seems that the bulk of it has disappeared since Mr. Draghi’s comments in late July.
A reasonable guess is that the risk of a breakup of the euro zone might still be inflating Spanish yields by one percentage point and Italian yields by 0.75 percentage point.
If the E.C.B. used those numbers to guide its bond-buying program, 10-year borrowing costs would drop to 4.7 percent for Spain and 4.4 percent for Italy.
To fall further, the countries would need to take more action themselves. Although investors are relatively optimistic about Spain and Italy, they are notoriously fickle.
Mr. Rajoy and Mr. Monti should remember how the good mood, engineered at the start of the year by the E.C.B.’s €1 trillion, or $1.28 trillion at current rates, in inexpensive long-term loans to banks, vanished with the spring.
Italy and Spain are also facing tougher political challenges than they were at the start of the year, when their new prime ministers were enjoying their election honeymoons.
Their economies have declined this year and will continue to do so next year; they are expected to shrink about 5 percent over the two-year period, according to Citigroup estimates. For all these reasons, Mr. Rajoy and Mr. Monti must not dawdle.
Assuming the German constitutional court this week backs the creation of the European Stability Mechanism, the euro zone’s permanent bailout fund, the Spanish prime minister should apply immediately. Italy, a richer country, should still be able to avoid a bailout.
But to do so it needs to cut its public debt, ideally with a vigorous privatization program and the creation of a wealth tax. With elections next April and no guarantee that an effective government can be formed thereafter, there is only a tiny window for action.
Mr. Monti’s technocratic government needs to jump through it. The E.C.B. has put its credibility on the line with its new bond-buying plan.
The Bundesbank, Germany’s central bank, has attacked the plan on the grounds that it has come close to breaking treaty provisions banning the E.C.B. from bailing out governments.
For now, Mr. Draghi can withstand the criticism, as long as Chancellor Angela Merkel of Germany keeps backing him.
But if Mr. Rajoy and Mr. Monti do not move fast, the E.C.B.’s magic will wear off. And if its medicine then fails, it will be hard to conjure up the political will for an even more powerful concoction.
nytimes.com
But if they drag their heels, the market will sniff them out. It will then be almost impossible to come up with another plan to rescue the euro zone’s two large problem children and, with them, the euro.
The promise in late July by Mario Draghi , president of the European Central Bank, to “do whatever it takes to preserve the euro zone” has already had a notable effect on borrowing costs for Madrid and Rome.
Ten-year bond yields, which peaked at 7.6 percent and 6.6 percent, respectively, a few days before Mr. Draghi made those comments, collapsed to 5.7 percent and 5.1 percent Friday .
Most of the decline came before Mr. Draghi spelled out Thursday the details of how the bond-buying plan would work .
What makes the program powerful is that the E.C.B. has not set a cap on the amount of sovereign bonds it will buy in the market.
The central bank’s financial firepower is theoretically unlimited, whereas the euro zone’s own bailout funds do not have enough money to rescue both Spain and Italy. But the new type of intervention has three important limitations.
First, the E.C.B. will only buy a country’s bonds if its government agrees to a bailout program with the euro zone and sticks to “strict and effective” conditions detailed in such a deal. Second, the central bank will focus its purchases on bonds with a maturity of one to three years.
Finally, Mr. Draghi has not specified how much he wants to drive down the borrowing costs for Madrid and Rome.
This fine print makes sense. But it also means that there is no free lunch. While the E.C.B. is unlikely to dream up new economic changes for Spain and Italy, it will probably want those countries’ governments to put more precise time frames around what they are already supposed to be doing.
The involvement of the International Monetary Fund, which has a somewhat unfounded reputation as a bogeyman, will also be sought. No wonder neither Prime Minister Mariano Rajoy of Spain nor Prime Minister Mario Monti of Italy is rushing to take advantage of the plan.
Meanwhile, the E.C.B.’s focus on short-term bonds means Spain and Italy will have to find some other way of issuing long-term debt, which accounts for 66 percent and 62 percent of outstanding debt, respectively.
If they lose access to the markets, the zone’s bailout funds would have to ride to the rescue. But the zone still would not have enough money for both countries. What is more, Spanish and Italian borrowing costs are still too high for comfort.
The E.C.B.’s main justification for buying bonds is that investors are unfairly punishing them because of fears that the euro zone will break up. But it also recognizes that the spread between their bond yields and the German 10-year borrowing cost of 1.5 percent is only partly due to such “convertibility risk.”
It is also attributed to bad economic policies. Although there are no scientific measures of convertibility risk, it seems that the bulk of it has disappeared since Mr. Draghi’s comments in late July.
A reasonable guess is that the risk of a breakup of the euro zone might still be inflating Spanish yields by one percentage point and Italian yields by 0.75 percentage point.
If the E.C.B. used those numbers to guide its bond-buying program, 10-year borrowing costs would drop to 4.7 percent for Spain and 4.4 percent for Italy.
To fall further, the countries would need to take more action themselves. Although investors are relatively optimistic about Spain and Italy, they are notoriously fickle.
Mr. Rajoy and Mr. Monti should remember how the good mood, engineered at the start of the year by the E.C.B.’s €1 trillion, or $1.28 trillion at current rates, in inexpensive long-term loans to banks, vanished with the spring.
Italy and Spain are also facing tougher political challenges than they were at the start of the year, when their new prime ministers were enjoying their election honeymoons.
Their economies have declined this year and will continue to do so next year; they are expected to shrink about 5 percent over the two-year period, according to Citigroup estimates. For all these reasons, Mr. Rajoy and Mr. Monti must not dawdle.
Assuming the German constitutional court this week backs the creation of the European Stability Mechanism, the euro zone’s permanent bailout fund, the Spanish prime minister should apply immediately. Italy, a richer country, should still be able to avoid a bailout.
But to do so it needs to cut its public debt, ideally with a vigorous privatization program and the creation of a wealth tax. With elections next April and no guarantee that an effective government can be formed thereafter, there is only a tiny window for action.
Mr. Monti’s technocratic government needs to jump through it. The E.C.B. has put its credibility on the line with its new bond-buying plan.
The Bundesbank, Germany’s central bank, has attacked the plan on the grounds that it has come close to breaking treaty provisions banning the E.C.B. from bailing out governments.
For now, Mr. Draghi can withstand the criticism, as long as Chancellor Angela Merkel of Germany keeps backing him.
But if Mr. Rajoy and Mr. Monti do not move fast, the E.C.B.’s magic will wear off. And if its medicine then fails, it will be hard to conjure up the political will for an even more powerful concoction.
nytimes.com
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