Two weeks ago I wrote a post about Mario Draghi and what appeared to be ECB’s step across the Rubicon into the arena of politics and fiscal policy in order to force Europe’s politicians to break the ‘chicken and egg’ stand-off that has plagued Europe for over a year. In that post I described his actions as a bluff called of both sides of the divide:
… the structure of what Mr Draghi has proposed is quite clearly jawboning of both sides of the economic divide to force a resolution. Although we have heard promises from Germany that they will support the periphery after they enact fiscal reform the ECB now appears to be calling their bluff. In open defiance of the Bundesbank and some in the German political camp the President offered the possibility of open ended and unsterilised bond purchases.
Meanwhile he is also calling the bluff of the periphery by making it very clear that this is completely dependent on compliance from southern nations on enactment of the fiscal compact.
This obviously wasn’t the first time the Mario Draghi had turned the screws on the politicians, I reported on another such time in July, but this was a significant move forward in the on-going politicking around the future of the Eurozone. I said in that piece that there were still some fairly large technical details to work through and, of course, the question was would the bluff call work.
Since I wrote those words there have been rumours that the ECB was looking at different strategies of how they could put a ceiling on Euro short term debt, specifically Italian and Spanish. This rumour saw a rapid correction in bond markets as they took on the news of future ECB support. This was, however, quickly unwound when the Bundesbank released a report questioning the ECB’s actions and stating that they were unsupportive of such moves. The ECB also later denied that any such action was about to take place.
The next day, however, Ambrose Evan-Pritchard wrote a piece claiming that there was some truth to the matter, and not only that, but Jorg Asmussen, Angela Merkel’s personal pick for the ECB board, was supportive of action by the ECB under the guise of insuring that the markets saw the euro was ‘irreversible’. Against opinions from the Bundesbank, Mr Asmussen stated that the ECB has the mandate to act because rising yields in the periphery are a reflection, in part, about the reversibility risk of the Euro and this in itself means that monetary policy transmission is being hampered.
I do personally think this is correct but, as I’ve stated many times previously, this is an issue of fiscal not monetary policy. That point aside, it now appears that Mr Draghi has called the bluff of the Germans and it has worked. Obviously I am taking this with a quite a bit scepticism , and it may just turn out that the Europeans have finally woken up to the fact that telling the markets what they want to hear would give them a free ride until the German constitution court decides on the ESM. But, at least at this stage, this does appear to be a genuine breakthrough.
There are , of course, two sides to this deal and we have heard nothing from Italy and/or Spain that suggests they are about to ask for a bailout via the ESM/EFSF which would trigger such a response from the ECB. In fact, by suggesting that the ECB may act the yields on sovereign bonds have fallen sharply. This has allowed Spain to sell €3.5 billion in 12-month bills at an average interest rate of 3.07 percent compared with 3.92 percent in the last such auction and €981 million in 18-month bills at a yield of 3.33 percent, down from 4.24 percent.
That’s not to say that I don’t think that both countries won’t eventually be forced to ask for help. Neither is on a sustainable path under the Euro with their current economic conditions, and it is very clear from the PMI data and other macroeconomic metrics that the situation is getting worse for both countries, particularly Spain. Incidentally we will get another round of PMI data tomorrow night.
There is, however, no doubt that, if true, this is a major step forward in European economics and the fact that the ECB may come to act like a real lender of last resort cannot be understated. The major issue of the Eurozone is the economic imbalance of the countries under a single currency and it appears the ECB is attempting to step into that breach where the politicians will not.
There are obviously a many more major steps to take on the road to a true economic union but this is most definitely a step in that direction, and the fact that the Germans appear to be supportive for the first time in years, if in fact it is true, should not be underestimated.
I do, however, still have major reservations about the way forward and I think there are significant political risks in Spain, Italy, Finland and Holland, amongst other nations, about taking the next steps because it will require a further loss of economic and political sovereignty. I also have considerable problems with the fiscal compact, as Yves Smith so eliquantly put it in a lead in to a re-post at Naked Capitalism:
.. Draghi might have found a path through the Euro mess to keep it patched up long enough for to impose austerity on the periphery and drive all of Europe into a lovely depression.
But, as they say, while the sun shines.