Economy Sep 6, 2012
European Central Bank chief Mario Draghi faces the most decisive moment of his presidency on Thursday when he tries to heal divisions among policymakers and deliver on his promise to save the euro.
Investors want to hear how the ECB will start a new bond-buying programme to help bring down the borrowing costs of Spain and Italy, after disagreements on the Governing Council over the plan were played out in public last week.
Renewed ECB intervention in the eurozone's bond markets is crucial for buying governments time to come up with a longer-term response to the bloc's debt crisis.
However, Germany's Bild newspaper reported that Jens Weidmann, who heads the Bundesbank, considered quitting over the disputed plan although he was dissuaded from doing so by his country's government. His predecessor Axel Weber resigned last year over the ECB's first bond purchase programme.
Investors are looking for Draghi to back up his promise on July 26 to do "whatever it takes" to preserve the euro, when he speaks after the Governing Council meets on Thursday.
"This meeting is absolutely crucial, because expectations are extremely high. If the ECB does not deliver, we will get into another bad patch," said Gilles Moec, senior European economist at Deutsche Bank.
Spanish and Italian government bond yields have fallen significantly since Draghi said on August 2 that the ECB would buy bonds issued by Madrid and Rome.
However, the debt purchases-which would succeed the ECB's Securities Markets Programme that has been dormant since March - would resume under strict conditions and only if the countries first sought help from the eurozone rescue fund.
Markets have been expecting Draghi to unveil a bold plan after Thursday's monthly policy meeting. But while he is likely to deliver a framework for new bond purchases, he will give no details of planned amounts or explicit targets for yield spreads or levels of interest rates, two central bank sources said.
"A number of investors expect that the button will be pushed without further ado, but it is a bit more complicated than that," Deutsche Bank's Moec said.
SECURING MAJORITY SUPPORT
Securing majority support on the Council for a plan Weidmann can live with represents the biggest balancing act Draghi has faced since he took over the ECB presidency on November 1 last year.
Weidmann has expressed concern that intervening in the bond market to reduce the borrowing costs of struggling euro zone countries such as Spain and Italy-which had reached levels that were unaffordable in anything but the short term - would break the ECB taboo of financing eurozone member states.
Other ECB policymakers see a greater urgency to help Spain and Italy to prevent the euro zone crisis from deepening.
One of the sources said the ECB is keen to attach strict conditions to its new programme. These will be enforced by the International Monetary Fund -which has a reputation for being tougher than European Union institutions - to keep up the pressure for reform.
Due to the paperwork involved in requesting such intervention, the source added that the ECB is unlikely to start buying bonds as soon as Thursday.
The Governing Council would decide on a case-by-case basis and keep close tabs on the programme, one source said, while the other source ruled out a shock-and-awe approach, in which the ECB would start off by buying huge amounts to impress markets.
The ECB was prepared to waive its senior creditor status on bonds it purchased-meaning it would be treated equally with private creditors in case of default.
"There is a problem if central banks insist on the preferred creditor status, because the more the public sector intervenes in the bond market, the less interest private investors will have," said one of the sources, who has seen preparatory documents for the Council meeting.
ALL ABOUT BOND BUYS
The terms of ECB intervention, which Draghi is expected to lay out when he reports the Council's decisions at a news conference at 1230 GMT, will determine whether Spain seeks help.
Prime Minister Mariano Rajoy said on Sunday that Spain, the eurozone's fourth largest economy, would consider seeking extra aid on top of an up to 100 billion euro rescue of its banks, but he wanted to see details of the ECB's programme before deciding.
"I do not think that the involvement of the IMF would weigh on the decision," said Javier Amador, economist at BBVA Research. "The IMF is being directly or indirectly involved in the different programmes already in place."
Spain is in recession and a quarter of its workers are out of a job, meaning tax revenue is falling and this is undermining the government's austerity drive.
Economies in the eurozone are drifting further apart with troubled countries such as Greece, Portugal and Spain at one end of the scale and Germany still growing at the other. This means the ECB's record low interest rate of 0.75 percent is too high for some and too low for others.
One of the sources said the meeting would focus on bond buying, which meant there "would be no time to discuss interest rates".
"It's all about the bond programme," the source said.
The Council, however, is expected to broaden the list of securities banks can pledge as collateral at the ECB in return for cash, something that will be particularly important for Spain's ailing banking sector.