ECB In The Limelight

07/09/2012 at 2:40 pm 1 comment

Towards the end of July, Mario Draghi, President of the European Central Bank, promised to do “whatever it takes to preserve the euro.” For a few weeks, equity markets pushed slowly higher, the euro recovered some of the ground it had lost since the spring, bond market panic began to subside and observers watched nervously for the actual ECB policy.

Yesterday it was announced. The eurozone’s central bank will buy as much short dated government bond debt as it takes “to prevent potentially destructive scenarios.”

There are conditions attached. Bond purchases will be “sterilized” by offsetting the amount bought with liquidity reductions in money markets; in other words, the eurozone’s money supply will not increase. So this is not “quantitative easing”. In fact it can be seen as a corollary to Draghi’s last big move: extending ECB lending to the banking system out to three years last December (an operation which saw interest of almost half a trillion euros on day one).

What makes this necessary, of course, is the power of the bond market to kill economies and the impact this has had on confidence – in the more troubled eurozone countries, and across the world. Thus far Draghi’s announcement has served to consolidate rallies in “peripheral” eurozone debt: 5 year Portuguese interest rates have fallen from over 11% when he made his July announcement, to 7.1% on Wednesday, to 6.1% today; the 2 year yield in Spain has more than halved from over 6% to 2.8% over the same period; Italy’s ten year benchmark has come down from 6.5% to just over 5% – and so on. With luck, this will help turn confidence around in the real economy and allow the world recovery to pick up a little steam.

With luck, because this is far from being a foregone conclusion.

Firstly, there are those with the strongly held conviction that the euro is a concocted deadweight born of an aberrant political vision, irrevocably destined to collapse. For them, Draghi has wielded “a pea shooter rather than a bazooka”; and whatever anybody does now or in the future, “the eurozone is simply doomed.” Restoring confidence where there was none to begin with is an impossible task.

Secondly, confidence is a skittish thing. We saw this last autumn, when positive market reaction to the October talks in Europe was derailed completely by the announcement of a referendum on their outcome in Greece. That country’s emergency creditors are in Athens again this weekend, and will decide over the next few weeks whether or not to advance a further bailout tranche (due next month). Another disaster could very well impact sentiment again.

So good luck to Mario Draghi – but he’s not the only game in town.

This blog observed early in the year that economic data and market confidence were being pulled in two directions. On the one hand, Europe continued to drag along and threaten financial cataclysm. On the other, fear over a double dip recession in the US was unwinding rapidly and signs of improvement in the labour market in particular were giving markets encouragement.

Yesterday’s strong open in New York lifted European markets well above the levels they had reached while anticipating and reacting to the ECB’s rate decision and press conference. This was partly due to a stronger than expected US service sector growth indicator and stable data on unemployment insurance claims. Overnight, the combination of good news from the world’s most significant developed economies saw China’s Shanghai Composite Index rise by almost 4%.

The ECB got all the limelight yesterday. The defence of the eurozone from collapse remains a significant driver of market behaviour. But the failure of the US to grind to a halt is important too. Ultimately, we will know that confidence has truly returned when ECB press conferences aren’t making headlines all over the world.


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