The SMP is dead! Long live the SMP!
OMT? Surely they could have just called it SMP2
What am I talking about?
Overnight Mario Draghi announced the new emergency program designed to support the ailing Eurozone. Most of the package was leaked out prior to the meeting so it wasn’t too much of a surprise when it was announced. The “unlimited” scale was, however, certainly an upside surprise.
The new program will be called OMT which means “Outright Monetary Transactions” and is a replacement of the Securities Markets Program (SMP) which the ECB previously used to purchase €209bn of EZ sovereign bonds. The SMP had been dormant for 5 months.
The OMT will have a pre-condition that any country receiving its benefits must already be under a EFSF, ESM, ECCL, or similar with a binding fiscal adjustment program in place preferably under the guidance of the IMF. The OMT will concentrate on purchasing sovereign bonds with a >3 year maturity in the secondary market and will have an unlimited capacity to do so. There will be no pre-announcement of the scale of any purchases or of any target yields. Importantly the ECB has also removed seniority on the program so that private sector actors in the primary and secondary markets will be on-par with the official sector in the case of default.
The ECB has also announced that it has reversed and removed collateral rules for Eurozone bonds as long as the issuing nation is “compliant” with the terms of an EU program. Basically this means that the ECB will ignore CRA sovereign ratings on EZ paper. All operations are to be sterilised via ECB fine-tuning operations alone the same lines as the SMP and Mr Draghi stated that the program will be stopped immediately if a country is found to be not complying with its fiscal program. This particular part I find difficult to believe.
Mr Draghi announced there was only one dissenting vote in the Executive Council for this new program, it isn’t hard to guess who that was given this statement from the Bundesbank:
“In the most recent discussions, as before, Bundesbank President Jens Weidmann reiterated his frequently substantiated critical stance towards the purchase of government bonds by the Eurosystem.
He regards such purchases as being tantamount to financing governments by printing banknotes. Monetary policy risks being subjugated to fiscal policy. The intervention purchases must not be permitted to jeopardise the capability of monetary policy to safeguard price stability in the euro area.
If the adopted bond-purchasing programme leads to member states postponing the necessary reforms, this will further undermine confidence in the political leaders’ crisis-resolution capability. This underscores the crucial importance of ensuring both credibility in the promised conditionality and the resolute determination to immediately terminate intervention purchases if the underlying conditionality is no longer assured.
The announced interventions in the government bond market carry the additional danger that the central bank may ultimately redistribute considerable risks among various countries’ taxpayers. Such risk-sharing, however, can be legitimately authorised solely by democratically elected parliaments and governments.”
Given the structure of the program I see no reason why governments won’t now adjust their bond programs down to the short end of the curve in order to come under the ECB umbrella. Mr Draghi was asked about that response and didn’t appear to have an answer as to how he could stop it occurring.
So all up the announcements were quite impressive, in fact under the political circumstances it is difficult to see how Mario Draghi could have delivered any more. That said, the pre-condition for any of this is the binding implementation of the fiscal compact so this program is more about “keeping the lights on” than fixing the broader issues of Europe. We’ve previously seen two similar, but limited, programs from the ECB and in that time the economies of the zone have weakened further, I have no expectation that this program will change that trend. As I’ve said previously these programs are simply the inevitable response to the attempts to implement supra-Eurozone austerity under an incomplete economic framework.
Positively, however, this again shows that when Europe has it’s back to the wall it can deliver and does suggest that there is still some potential for a slow move towards a true economic union in the zone, even if it takes some blackmailing to get there. Obviously I’ll caveat that with the response we get from politicians from both sides of the divide over the coming days, particular from Spain and Germany.
The full press conference is below: