As long as indebted governments ask the official bailout mechanisms for help and put in place strong plans to get their finances back on track, the ECB will consider buying their bonds with its new programme – dubbed Outright Monetary Transactions (OMT).
But Draghi warned that the underlying problems in the Eurozone remain, and that action to reduce borrowing costs would not eliminate the major differences in competitiveness between Germany and the peripheral nations that are the cause of much of the crisis.
Draghi repeated his pledge to “do whatever it takes” to keep the euro together, and forced his way past German objections by arguing that financial markets are so fragmented that monetary policy cannot properly operate and so the ECB needs to act if it is to meet its target of price stability.
Just one member of the bank’s committee – thought to be Germany’s Jens Weidmann – opposed the new OMT proposals, showing the depth of support for the move across Europe.
Spain and Italy are the most likely countries to need the support of the ECB, as their governments are fighting an uphill battle against major budget deficits, inflexible economies and growing recessions.
But Draghi insisted he will only step in after they have sought financial aid from other Eurozone governments.
“Governments have to stick to their fiscal and economic reform plans before the ECB acts,” he announced.
“They have to go to the European Financial Stability Facility (EFSF) because the ECB cannot replace governments and the action of other institution on the fiscal side.”
When the purchases do take place in secondary markets, they will be focused on bonds with maturities of between one and three years.
“There was no single incident which led us to introducing this, but one element was the sudden increase in yields at the shorter part of the curve for several Eurozone countries,” said Draghi.
“For people who know the markets, this is usually ominous.”
There will be no set target, with no explicit yield cap, but the purchases are likely to be sterilised – meaning the ECB takes in deposits equal to its purchases, to avoid flooding the Eurozone with new cash. The purchases will not be senior to privately-held bonds.
Analysts welcomed the proposals, though the exact details are still to be worked out in the coming weeks.
“Any lowering of government financing costs should help to prevent Spain and Italy needing to turn to a full sovereign bailout and moderate some of the government’s financing costs,” said Investec’s Philip Shaw.
However, the action is unlikely to be the so-called bazooka solution to the crisis that some were hoping for.
“Borrowing costs are mostly a symptom of the underlying differences and problems – not a cause,” said Raoul Ruparel from Open Europe.
“Unless these issues – mismatched competitiveness, undercapitalised banks, lack of growth prospects and political uncertainty – are tackled then masking the gap in borrowing costs can only, at best, buy time.”
Markets jumped on the announcement, with stocks soaring and government borrowing costs plummeting.
Italian shares boomed, sending the FTSE MIB up 3.54 per cent, closely followed by the Spanish IBEX which jumped 3.41 per cent. The American S&P hit its highest level in more than four years. And the Spanish government’s 10-year borrowing costs dropped sharply, falling 0.379 percentage points to 6.03 per cent – and briefly falling below the six per cent mark for the first time since June.
Italian 10-year yields fell 0.253 percentage points to 5.261 per cent – the lowest level since the start of April.
■ STERILISATION The European Central Bank does not want to print money and pump it into the economy in the same way as the US Federal Reserve and Bank of England have done. Instead it buys government bonds and absorbs an equivalent amount in deposits from banks, taking the same amount of money out of the system.
■ CONDITIONALITY Draghi does not want to give governments help without promises that they will work hard to sort out their finances. The aid will only be given if governments seek financial help from the EU’s bailout funds, and promise tough economic reforms.
■ RATE CAPPING Borrowing costs are worryingly high in some Eurozone countries – Spanish 10-year interest rates peaked at above 7.6 per cent earlier this year. The ECB wants to bring those rates down by buying bonds, and some supporters of this want the central bank to give markets more confidence by promising to cap yields at a set level and buying as many bonds as it takes to hold that.
■ COLLATERAL The ECB usually only provides cash to banks if they offer a security in return – for example, mortgages or corporate loans. This is called collateral, and means the ECB has an asset to sell if the bank cannot pay back the loan. Yesterday, Draghi cut collateral standards, letting banks provide almost anything.
■ EFSF The European Financial Stability Facility is the Eurozone’s temporary bailout fund, while the European Stability Mechanism is the permanent fund. Backed by Eurozone governments, the EFSF and ESM can raise funds on the bond markets and subsequently lend it to troubled governments. The ECB will only buy a government’s debt if it has already gone begging to these funds.
■ SECONDARY MARKETS The ECB is not allowed to finance government spending directly, so buying bonds directly from states is not allowed. Instead, it buys them on the open market – bonds which were issued at some point in the past, then traded between institutions like banks. It still drives down yields, but is presented differently and is less direct.