26 February 2013

FT: Fears ECB bond scheme has its weakness

When the ECB unveiled its new programme to buy eurozone bonds last September, EU officials were quick to tout its differences from previous schemes: It would not only be unlimited, but also conditional on a struggling country living up to Brussels-mandated economic reforms.

In the wake of this week’s chaotic Italian elections, some investors and analysts are now concerned that such strings, once hailed as the programme’s strength, may in fact be its Achilles' heel. With a long and potentially unstable period ahead for Rome as it attempts to cobble together a new government, Italy may be without the kind of credible policy decisions that are preconditions to gaining access to ECB assistance.

It is hard to overstate the importance the ECB bond-buying programme, known as Outright Monetary Transactions, has had on the three-year-old crisis. Within EU policy circles, it is widely accepted that OMT was the most important element in stopping the panicked flight from the eurozone’s periphery last year, a turning point many believed had finally ended the crisis’ acute phase. By pushing the programme through despite opposition from Germany’s central bank, many officials believed ECB chief Mario Draghi had finally given the eurozone the “bazooka” it long needed: the central bank’s printing presses. Investors no longer had reason to fear their holdings would default or lack for buyers.

But Mr Draghi has long been clear about the strings attached. Before the ECB buys a single bond of a country in trouble, its government must first submit to a programme designed by the eurozone’s €500 billion rescue fund, the European Stability Mechanism, which envisages strict and effective conditionality spanning the fiscal, macro-economic, structural and financial spheres.

Those are exactly the sort of conditions Italy’s voters rejected in this week’s election and that a weak government, which could include overtly anti-austerity parties led by either former prime minister Silvio Berlusconi or populist outsider Beppe Grillo, would be loath to enforce. For its part, the ECB has been so explicit about the need for the fiscal conditions attached to OMT that it would be difficult to justify deploying the programme without securing a pledge of fiscal rigour from an Italian government.

While EU officials said they accepted the democratic verdict in Italy, several also emphasised the importance of a future Italian government living up to EU-mandated commitments – a precondition for a future OMT programme – though the direct tie to any future assistance was not explicitly mentioned.

Full article (FT subscription required)

© Financial Times