ECB Fleshes Out a New Facility to Buy Sovereign Bonds

September 6, 2012

There was one dissenter, presumably Germany, to today’s decision to launch Outright Monetary Transactions (OMT), which will purchase in the secondary market unlimited sovereign bonds with a maturity of between one and three years. Unlike prior efforts to buy such assets, the OMT has “strict and effective conditionality,” namely that the mandate is not jeopardized of securing medium-term price stability and provided that nations to participate in the program first agree to an appropriate program of macroeconomic adjustment with the EFSF/ESM.  The European Governing Council will exercise full independence in deciding where to utilize the OMT facility, how much to do, and when to suspend operations if conditionality is violated

Four intents of the OTM are to dispel the unfounded notion of euro reversibility, “to safeguard the monetary policy transmission mechanism, to preserve the singleness of monetary policy, and to ensure proper transmission of monetary policy to the real economy.”  ECB Pdt Draghi’s statement then asserts that “under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”  

Reporters at the press conference expressed misgivings that Germany has seemingly dissented once again and that previous bond buying programs had not proved effective.  Draghi, in response, stressed Germany’s isolation in an almost unanimous accord of the Governing Council and the unique features of conditionality that earlier bond buying lacked.

The Governing Council considered but decided against a cut of its key interest rates on the grounds that it would be best not to take such action at the same time as the OTM is launched.  The refinancing rate will stay at 0.75% and be flanked by a deposit rate of zero and a marginal lending rate of 1.50%.  Cuts of 25 basis points to these levels were announced on July 5.

The formal ECB statement included newly revised staff projections for economic growth and CPI inflation in the euro area for 2012 and 2013.  Their evolution from previous quarterly projections is documented in the table below.  Projected GDP expansion has been nudged downward, and any likelihood of positive growth in 2012 has been abandoned.  Projected inflation was bumped slightly higher, but the 1.9% projected range midpoint in 2013 remains within the ECB target.  As before, the forecast for growth is associated with downwardly biased risks, while the inflation profile is surrounded by balanced risks.

  GDP 2012 GDP 2013 CPI 2012 CPI 2013
09/12 -0.6%/-0.2% -0.4%/1.4% +2.4%/2.6% +1.3/2.5%
06/12 -0.5%/+0.3% 0.0%/2.0% +2.3%/2.5% +1.0%/2.2%
03/12 -0.5%/+0.3% 0.0%/2.2% +2.1%/2.7% +0.9%/2.3%
12/11 -0.4/+1.0% +0.3/2.3% +1.5/2.5% +0.8/2.2%
09/11 +0.4/2.2%   +1.2/2.2%  
06/11 +0.6/2.8%   +1.1/2.3%  
03/11 +0.8/2.8%   +1.0/2.4%  
12/10 +0.6/2.8%   +0.7/2.3%  

From a qualitative standpoint, the latest ECB statement maintains that

  • GDP growth will remain weak, dampened by balance sheet adjustment, high unemployment, and the unevenness of the recovery.
  • Monetary growth remains subdued.
  • Inflation expectations continued to be anchored firmly and tethered to the ECB’s definition of price stability.
  • Renewed intensification of financial market tensions would have the potential to affect the balance of risks for both growth and inflation.
  • The proposed OMT is “strictly within the mandate to maintain price stability over the medium term.

It was not entirely clear when the first bond buying will be done.  On a weekly basis, the ECB will publish its aggregate OMT holdings and their market values.  Each month, officials will additionally disclose the country breakdown of its holdings and the average duration of its portfolio.

The ball is now in the market’s court to give a vote of confidence or no confidence in the new initiative.  Watch how the euro and peripheral bond yields move to learn the answer.  The next ECB press conference is scheduled for October 4th.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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