It would be odd to suggest that one of the most scathing critiques of the ECB's attempts to talk up the market on nothing but hope, promises and expectations would come from rating agency Moody's, yet that is precisely what has happened. With Swiss, Dutch, Finnish, and German short-dated bonds once again hitting new record low (negative) rates (and Italian 10Y is weakening), it would appear that at least some of the market is not drinking the all-things-risk kool-aid.
Alistair Wilson, Moody's: Draghi Reaffirms ECB’s Willingness to Buy Time, but ECB Cannot Resolve Debt Crisis
Last Thursday, Mario Draghi, the President of the European Central Bank (ECB), said that “within [its] mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The statement lifted market sentiment and sent Spain’s 10-year government bond yields back below 7%.
Media and market commentators have interpreted Mr. Draghi’s remarks as an indication that the ECB is willing to do more to support pressurized euro area sovereigns, for example by expanding the securities markets program (SMP) with further government bond purchases.
In fact, the statement was a supportive but very general one that contained no specific proposals and offered no firmer prospect of the crisis being resolved quickly. It reaffirms our view that the ECB will ultimately do all it can to support policy makers’ efforts to resolve the crisis. However, that is a necessary but not a sufficient condition for the euro area authorities’ current strategy to succeed.
The assumption of ECB support is central to the credibility of the authorities’ ‘muddle-through’ strategy for resolving the crisis – a reactive and gradualist approach that makes periodic shocks inevitable. The ECB’s willingness to act in a way that, by bolstering investor confidence in peripheral sovereigns, temporarily supports those countries’ continued access to debt markets, is a crucial element of the strategy. The ECB’s capacity to provide such support was amply demonstrated with the introduction of the three-year long-term refinancing operation in December 2011. Were the ECB unwilling to act in this way, the authorities’ muddle-through strategy would be unlikely to succeed.
However, the ECB can do no more than buy time: its actions alone will not resolve the debt crisis. Resolution will ultimately rest on achievement of fundamental changes to member states’ budgetary positions and debt stocks, on structural economic changes required to stimulate growth, and on institutional reform to the economic and fiscal governance of the euro area. Each change will take years to accomplish, and support from the ECB will be essential to the preservation of the euro in the meantime.
The timing of Mr. Draghi’s statement is significant. With the July Summit having failed to reassure euro area sovereign investors, and Spanish and Italian government bond yields having risen substantially over recent days, Mr. Draghi’s statement indicates the level of concern among euro area policymakers. It illustrates the extent to which current financial market conditions are credit negative for issuers across the euro area.
Moreover, notwithstanding the strength of Mr. Draghi’s statement, significant areas of disagreement remain between members of the ECB’s Governing Council on how the ECB should respond. Ewald Nowotny (president of the Oesterreichische Nationalbank and member of the ECB’s Governing Council) recently suggested, in a statement to Reuters, that the European Stability Mechanism should be constituted as a bank in order to be able to borrow from the ECB, a suggestion that the ECB has firmly rejected in the past.
Conversely, subsequent to Mr. Draghi’s statement, a Bundesbank spokesman suggested that expanding the SMP was “problematic”. These conflicting remarks illustrate the diverging views that have dogged the euro area authorities’ policy development and significantly contributed to the depth of the crisis.