Yesterday I noted what a consequential week this would be for the European economy, as the European Central Bank prepared to make its decision on how to deal with soaring bond yields in Italy and Spain. ECB President Mario Draghi let some of the cat out of the bag yesterday, hinting that the central bank would purchase short-dated sovereign debt instruments from those nations.
European Central Bank President Mario Draghi told lawmakers he would be comfortable buying bonds with maturities of up to about three years, said Jean-Paul Gauzes, a member of the European Parliament.
Purchasing short-dated bonds doesn’t constitute state financing, Draghi said during a closed-door parliamentary session in Brussels today, Gauzes told reporters afterwards. “He thinks it’s not a violation of the treaty and you can do it under the current legal framework,” said Gauzes, a French Christian Democrat. “He said for example three years is ok, 15 years no.”
The euro rose against the dollar after the comments, which indicate Draghi may be in a position to announce details of the ECB’s new bond-purchase program after policy makers meet on Sept. 6. The European currency jumped more than a quarter of a cent to $1.2611 and traded at $1.2599 at 7:27 p.m. in Brussels, up 0.2 percent on the day.
Draghi said on Aug. 2 that the ECB was working on a bond-buying program to lower yields in countries such as Italy and Spain as long as they also ask Europe’s rescue fund to buy their debt. Germany’s Bundesbank opposes government bond purchases and the country’s constitutional court won’t rule on the legality of the permanent fund, the European Stability Mechanism, until Sept. 12.
This is all coming together. Agreeing to purchase bonds of any maturity is a step beyond what the ECB has allowed themselves previously. Even at three years, it will help finance the state. So Draghi finding a loophole, saying that buying the assets constitutes “ensuring the transmission of monetary policy,” means that the bond-buying is likely to take place after the September ruling in Germany on the ESM.
However, Spain and Italy will have to beg the ECB for the privilege. Or, maybe not. Maybe just the indication that the ECB will act is enough to keep those short-term debt yields very low. In fact, the yields have been dropping dramatically ever since the news of the bond-buying program leaked out. Draghi may not have to buy anything at all; he may just do enough by indicating his commitment to the purchases. That would probably be his preference, if he didn’t also want to pull off a fiscal policy coup by forcing Spain and Italy into the euphemistically titled “labor market reforms” that would crush their unions and probably reduce wages. So intention without action isn’t only the best case for reducing risk on the ECB’s balance sheet, it’s the best case for Spanish and Italian workers.
Draghi has to iron out a few details, like whether he will insist on a cap on the spread between the rate of yields on Spanish or Italian debt relative to more stable German debt. But he’s clearly going to signal a willingness to act. Since we can expect a lag time before buying of a few months, this is actually a pretty decent test case as to whether it only takes communication to have a functioning monetary policy.