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February 14, 2012 at 09:55 AM
Moody’s downward adjustment of the sovereign debt of nine European countries was just the latest in a long series of negative assessments of Europe’s fragile economy. But while the headlines focused on Europe’s poor fiscal management and anemic economic prospects which threaten needed structural reforms, the credit rating agency signaled–somewhat vaguely–its strong support for the European Central Bank’s newly accommodative monetary policy.
“An important factor limiting the magnitude of Moody’s rating adjustments is the European authorities’ commitment to preserving the monetary union and implementing whatever reforms are needed to restore market confidence,” its rating action stated, adding its approval of unspecified “measures adopted to stem the risk of contagion.”
And indeed the European Central Bank, under the new leadership of Mario Draghi, has made a sharp departure in its monetary policy, most notably through its Long-Term Refinancing Operations, which very quickly made hundreds of billions of euros in cheap financing available to Europe’s sickly commercial banks, enabling them to make overnight profits by buying European sovereign bonds. The action simultaneously strengthened Europe’s banks and shored up Europe’s sovereign debt, while vastly expanding the ECB’s role in the eurozone economy much as the Federal Reserve has propped up the U.S. economy.
While the U.S. market–buoyed according to some observers by the Fed’s plans to extend its zero rate policy through the end of 2014–has enjoyed an extraordinary rally so far in 2012, rising over 7 percent year to date, European stocks have done even better, rising more than 8 percent so far this year.
The ECB has essentially reassured markets that it will not allow Europe’s banking system to fail and it will guarantee member states’ sovereign debt (while supervising an orderly restructuring of already bankrupt Greece). The ECB has already signaled a new, possibly larger LTRO program will be forthcoming, which is no doubt pleasing news to stock markets and credit rating agencies.
