European Central Bank’s president defies Germany by saying he will ‘do what it takes’ to rescue Spain and Italy, and safeguard single currency. European Central Bank president Mario Draghi prompted a strong rally in Europe’s financial markets yesterday when he pledged to do “whatever it takes” to safeguard the future of the single currency.
Shares, bonds and the euro all rose sharply after the ECB president dropped the strongest of hints that the bank was preparing to intervene to bring down the crippling borrowing costs affecting the Spanish and Italian governments.
In what was seen as the start of a power struggle with Germany’s Bundesbank, Draghi told a UK government-backed pre-Olympics business conference in London that the ECB had the legal right to act if the high bond yields caused by Europe’s sovereign debt crisis were making its interest rate policy less effective.
Germany has argued that the ECB has no legal right to copy the interventionist policies adopted by the US Federal Reserve and Bank of England, but Draghi said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro ... And believe me, it will be enough.” He added: “To the extent that the size of these sovereign premia [high bond yields] hamper the functioning of the monetary policy transmission channel, they come within our mandate ... we have to cope with the financial fragmentation and address these issues.” Financial markets rallied instantly on Draghi’s comments. Interest rates on Spanish 10—year bonds, which had peaked at 7.75% this week, dropped below 7%, while Italy’s 10-year bond yield slipped below 6%. Financial markets believe long-term borrowing costs of more than 7% are unsustainable and will eventually require a country to seek financial help.
The euro gained almost two cents against the dollar at just under $1.23, while the Madrid and Milan stock markets rose 6%. Hopes of ECB action to tackle the sovereign debt crisis also boosted sentiment in London, where the FTSE 100 climbed 75 points; in New York, the Dow Jones industrial average was 170 points higher in morning trading.
“These are potentially very significant remarks from the ECB president,” said Nick Parsons, analyst at National Australia Bank. “Until now we’ve had a none too subtle public row between the inflationary hardliners in the Bundesbank and the European Central Bank.
“Draghi has been heavily criticised by Buba [Bundesbank] chief Jens Weidmann but appears now to be publicly fighting back in defence of his vision of how monetary policy can - and will - operate in this era of sovereign debt crisis.” Parsons said he expected the ECB to massively increase bond purchases in the financial markets, adding that it was possible Draghi was also preparing to buy bonds directly from governments, a course of action fiercely opposed by Germany.
David Blanchflower, a former member of the Bank of England’s monetary policy committee, said the timing of Draghi’s comments were significant. “My suspicion is that he knows something we don’t.” Christian Schulz, senior economist at the German bank Berenberg, said the announcement could boost sentiment, but immediate action was unlikely.
“The ECB is the only institution that can credibly arrest any market panic, because it can act swiftly and has potentially unlimited pockets. The ECB might still wait for the decisions eurozone leaders may take on Greece and Spain in September after the permanent rescue fund, the European Stability Mechanism, has been established. The uncertainty may continue for some time.” Nick Spiro, from Spiro Strategy, expressed scepticism about the ECB’s capacity to deliver. “Markets love to hear ‘do whatever it takes’ utterances from Europe’s leaders whenever the eurozone crisis takes a turn for the worse. But they are particularly fond of hints from the ECB that it is looking at ways to overcome legal and political constraints to shoring up the bond markets of Spain and Italy - the issue which has concerned investors the most over the past year.” The IMF welcome Draghi’s remarks but its managing director, Christine Lagarde, said the eurozone needed to deliver on commitments to deeper integration agreed at the summit in June. “The eurozone needs a coherent fiscal, monetary and banking union if it is to overcome the sovereign debt crisis,” she said.
“This coagulation of member states does not translate into one single economic fiscal union. What happened on the 28 and 29 of June was welcome but it was step number one and it needs to be delivered upon.” Lagarde also seemed to push for greater political integration, but recognised the difficulties politicians faced. “It takes more than courage to go forward and say: ‘I’m surrendering part of my sovereignty; decisions on defence, decisions on budget and decisions on raising tax will be compounded by 16 other states; our banks will be supervised by the ECB.’” IMF officials were involved in talks in Athens yesterday with the Greek government over new austerity measures being demanded in return for financial help. Cuts in pensions and healthcare were under discussion when the so-called troika of the IMF, ECB and EU began negotiations.
Manuel Barroso, the EU president, also attended, in an attempt to defuse speculation that Greece may be forced out of monetary union. Government officials said they saw the massed forces as an endorsement of the new Greek administration’s determination to enforce unpopular changes on an economy that has lost close to 20% of GDP since its first bailout in May 2010.
The EU president urged Athens to push ahead with the reforms, emphasising that while the will exists to keep Greece in the bloc, it also had to show willing if patience is not to run out.
Media reports suggest Barroso will press the government to expedite the privatisation of loss-making-state-owned utilities - a programme that has barely got off the ground despite it being a cornerstone of Athens’s agreement with international creditors.
Although lenders have pledged to tide Greece over with a bridging loan if necessary to cover refinancing needs in August, further cash handouts will depend on the progress Athens is perceived to have made in enacting reforms.
Aides close to Antonis Samaras say the Greek prime minister will use the occasion to extract a message of “solidarity and support” from Barroso that the government is intent on meeting the commitments it has made to creditors. “We are very tired of constantly being portrayed as the problem child of Europe,” said one insider. “Remarks questioning our ability to stay the course are very unuseful.” This week, Samaras chastised “certain EU countries” for the “constant undermining” of Greece when it was trying to extract itself from an economic mire.