In a closed-door parliamentary session on Monday, European Central Bank (ECB) president Mario Draghi ignited a global market rally with the following reported statement: if the ECB was to buy bonds with maturities of up to 3 years this would not constitute state financing and is, thus, within the ECB’s mandate. This comment has been interpreted as a precursor to the European Central Bank's expected plan to purchase short term bonds for troubled sovereigns at the next meeting of the Governing Council on 6 September. But this is still all speculation. And Bank of America Merrill Lynch - along with Morgan Stanley - is more bearish than most on Thursday’s outcome:
| "We believe the ECB will discuss conventional and non-conventional monetary policy in its 6 September meeting with a view to supporting credit demand and restoring the monetary policy transmission mechanism. The main objective is to use all these tools to lower rates at which banks lend to the non-financial sector. To this effect, we believe the ECB will provide little clarification of the bond program – in the absence of any official demand for support – but will ease further collateral requirements and cut the refi rate by 25bp to 0.50% whilst leaving the deposit rate unchanged. Retaining as much discretion as possible is key for the ECB to maintain maximum flexibility in their interventions. We therefore believe the front-end of the periphery is vulnerable to a sell-off." |
If at all, bond buying will be set on a case-by-case basis with little clarification on the process:
| "At the last press conference Mario Draghi promised the ECB would explain the characteristics of its “new” bond buying program. As the ECB was to use the month of August to flesh out details, we know little on the future purchase program, other than that markets have high expectations. What is also certain is that the program will be conditional, ie, a country needs a MoU with the EFSF/ESM (as a necessary but not a sufficient condition) to benefit from ECB bond buying. Further clarification is expected on (1) the ECB’s seniority status, (2) the type of purchased securities (which markets understood as specifying the maturity of sovereign bonds to be purchased), and (3) possibly announcing the amounts of securities to be purchased. We believe markets may be expecting too much transparency from the ECB in the absence of any formal request for EFSF/ESM support: in our view, the ECB will only confirm it will focus sovereign bond purchases in the shorter end of the curve, and try easing the market’s seniority concerns." |
But a lack of clarification is set to kick off a vicious cycle:
| "Yet, Spain and Italy’s current yields do not exert enough pressure for them to ask for support at the moment, especially given the uncertainty about the type of intervention to be considered by the ECB, and therefore its effectiveness and ability to avert rating downgrades. In our view, pressure will only get high enough as time passes by and auction concessions set a widening move in motion, with markets skeptical about the scale of potential official support." |
Meanwhile, euro-watchers remain on tenterhooks as a pivotal meeting on September the 12th will decide whether or not the German Constitutional Court believes that the European Stability Mechanism is constitutional. And don’t forget, all this is happening against a backdrop of revised credit ratings by Moody’s on the Europe Union.