05 August 2012

Simon Nixon: A dose of Dr Draghi's 'whatever it takes'

Mr Draghi last week swatted objections aside, as he elaborated on what he meant by "whatever it takes". The ECB would be willing to intervene in bond markets, but only on behalf of countries that had already applied to the eurozone for aid, thereby ensuring conditionality; it said it would address investor concerns over seniority; and it would focus on buying short-term bonds to minimise credit risk and ensure any operation more closely resembled normal monetary policy.

As for the opposition of the Bundesbank, which has one vote out of 23 on the ECB's Governing Council, this was simply noted and ignored. The ECB had a duty to act, Mr Draghi said, because investors betting on a currency break-up had made it almost impossible for some countries to access funding.

Mr Draghi's message is don't fight the ECB, or as he put it: Shorting the euro is pointless. Short-term Spanish and Italian bond yields fell sharply on Friday and European equities rallied. But big questions remain unanswered: How exactly will the ECB address concerns over seniority? Will its operations be unlimited? What yields will it target? Will it operate in tandem with the eurozone bailout funds or on its own?

Meanwhile, the real challenge is to ensure funds flow back into troubled countries. But that depends partly on the markets believing those countries' debts are sustainable, which in turn depends on how their economies perform and whether their governments stick to their overhauls. Spain has a stable government now committed to reform, but the Italian and Greek situation is more volatile. Rising unemployment may test political legitimacy and boost fringe parties. The only other way to take convertibility risk off the table entirely is via debt mutualisation and fiscal transfers, but the degree of political union necessary to make this happen still seems a long way off.

Even so, one other development over the past fortnight may prove significant: Mr Draghi's promise to do whatever it takes was welcomed by both German chancellor Angela Merkel and finance minister Wolfgang Schäuble. For the German government to comment on monetary policy, let alone disagree publicly with the Bundesbank, is remarkable.

A hint of the tensions was revealed by Bundesbank chief Jens Weidmann in an interview for the central bank's internal magazine [view article]. Mr Weidmann complained that all central banks come under pressure to use monetary policy to tackle political problems, but their ability to withstand this pressure depends on whether the public has a "stability culture". Mr Weidmann clearly believes Germany has such a culture but fears countries with different cultures will try to pressure the ECB to inflate the eurozone out of trouble. Ms Merkel may share this fear but she faces her own election next year and neither wants the euro to collapse nor to have to ask parliament to support further bailouts.

It wasn't just Mr Draghi who blinked; Berlin did, too.

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