When the ECB waved its magic wand last month and announced that another acronym would save the day (OMT - outright monetary transactions - in case you have been sleeping in a bunker), eurozone watchers pondered over what would happen to the likes of Portugal, a member state that is already under a macroeconomic adjustment programme.
On the face of it, Portugal was given a lifeline: bond purchases “may be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access,” said the ECB. Ahead of that announcement, JP Morgan’s Malcolm Barr argued why it would make sense for the ECB to intervene in Portugal as soon as it re-entered the market.
Yesterday, Portugal exchanged €3.75bn of debt maturing in September 2013 for debt maturing two years later alongside an announcement of tax hikes to keep its consolidation and adjustment plan on track. On the whole, Portugal’s economic reforms and performance have been relatively strong, well, compared to its shrivelling neighbour Spain at least. Yesterday would have been perfect timing for the ECB to go into Portugal, argues Barr.
But this didn’t happen. So for the time being, “Portuguese authorities will continue to attempt to implement austerity amid declining GDP, but facing very short term interest rates which are inappropriately high,” says Barr.
What was the reason for this? Christian Shultz at Berenberg Bank told us:
| “Only a country with market access together with a program can benefit from ECB bond purchases. Portugal doesn’t have meaningful market access right now. Before the 2 October, Portugal only had access to the market through short term bills, and yesterday they issued their first bond swap. If they follow a similar pattern to Ireland, and issue a small amount of bonds in the primary market in a couple of months, then the ECB could legitimately intervene if monetary transition is under pressure then.” |
Moreover:
| “It is not in the ECB’s remit to intervene just to bring down borrowing costs. This would create a moral hazard, which the ECB wants to avoid.” |
For Barr, the reason stems from different sentiment:
| “Perhaps buying Portuguese debt on the inception of the programme was a step too far for the non-German members of the council. It may also have raised some tricky issues about (a) how to deal with the issue of Greek programme compliance, and (b) the operational detail of how to conduct the purchases on a day-to-day basis, that the ECB were not ready to answer on September 6th. These arguments do not strike us as very strong ones for the path the ECB has taken.” |
But not intervening in Portugal was misguided, for three reasons, argues Barr. Firstly:
| “It is simply bad policy. Why should countries who are deemed compliant with their overall macroeconomic adjustment programme have to wait until they are returning to markets before their monetary transmission is corrected? Even if such states are not issuing debt into the market, the yields on the outstanding stock of government paper matter for economic performance in a number of ways. They impact the value of assets held by banks and others, and hence credit availability and other asset prices. They also act as a reference point from which other interest rates are set. To the extent that countries are implementing fiscal tightening and structural reform, as specified in their adjustment programme, the need for monetary stimulus as an offset is very clear. In the case of Ireland, one can argue that rates on short term sovereign paper are sufficiently low that a correction of monetary transmission is not needed. But with Portuguese three year paper yielding near 5%, the case for intervention remains clear.” |
Secondly:
| “It undermines the ECB’s stated objective of OMT, which is to improve monetary transmission, and makes it look more like monetary financing of deficits. The fact that the ECB will intervene only in cases where sovereigns are actively seeking to sell debt into markets reinforces the idea that the OMT is really about providing a backstop to sovereign financing, rather than imposing monetary transmission.” |
And finally:
| “There are a number of tactical advantages to launching OMT in Portugal. Unlike Spain, a decision to launch OMT in Portugal does not need to be preceded by a political process of agreeing conditionality and the terms of official support, as this is already in place. Moreover, the market for Portuguese 1-3 year sovereign debt is relatively small, with less than €30bn outstanding. Hence it would not take a large scale commitment of the ECB’s balance sheet to have a very significant impact in yields, or to be able police yields at a low level. An early demonstration of the effectiveness of the OMT would help create a precedent to help distinguish it from the prior SMP in the eyes of market participants.” |