Rising yields on bonds for Spain and Italy prompted European Central Bank (ECB) President Mario Draghi to declare that the central bank will do “whatever it takes” to keep the euro intact, as eurozone central banks looked for new ways to spur bank lending and undo the bloc’s financial logjam.
Meanwhile, Spain refuted reports in German and Italian newspapers that it on the verge of asking the European Financial Stability Facility (EFSF) to buy bonds as a means of lowering yield.
Bloomberg reported Thursday that Draghi spoke in London to reassure markets that had driven yields for the two troubled countries to unsustainable levels. The ECB had halted bond purchases and resisted resuming them, but in his speech Draghi said, “To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate. We have to cope with the financial fragmentation, address these issues.”
He added, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
The euro rose in the wake of his comments, although the long-term nature of such a commitment is still to be determined. Chris Scicluna, an economist at Daiwa Capital Markets Europe in London, said in the report, “[Draghi’s] comments certainly suggest that ECB purchases of Spanish and Italian bonds are back on the table for discussion, as is another LTRO,” referring to a long-term refinancing operation. “But—just like last summer—we would expect any new ECB bond purchases to be temporary and limited until other policies are put in place.”
Next week will see meetings of policymakers from the Bank of England (BoE), the ECB and the Federal Reserve during a 24-hour period as they look for strategies to open up avenues of credit.
Nathan Sheets, global head of international economics at Citigroup in New York and director of the Fed’s international finance division until last year, said in the report, “Central banks are thinking hard about other ways to spur their economies and get credit into corners of the economies that need it and aren’t getting it.”
Some of the possibilities being considered, in addition to renewed efforts on earlier actions, are assuming some new lending credit risk onto their balance sheets and compelling commercial banks to pay for the privilege of putting their cash in the safe haven of central banks—the theory being that, if banks have to pay to hold cash, they may instead begin to lend in the hope of recovering some yield.
However, Roberto Perli, a former Fed economist and now managing director in charge of policy research at International Strategy & Investment Group in Washington, was quoted saying, “The lending channel is broken.” John Stopford, head of fixed income at Investec Asset Management in London, said in the report, “It’s not obvious central banks have been effective, but they’re going to keep trying.”
According to Ken Wattret, chief market economist for the euro region at BNP Paribas, Draghi’s comments caused investors to speculate that the ECB will go back to buying Spanish and Italian bonds. It halted the practice four months ago in an effort to compel governments to work harder at cutting their budget deficits.
Spain, meanwhile, was anxious to naysay reports that it would be seeking immediate aid. Two sources said that Madrid was not ready to ask the ECB to buy bonds. One was quoted in the report saying, “Neither a total rescue of the Spanish economy nor a bond-buying program from the EFSF is being looked at.”
The other source explained that the government was focused on putting in place mandates from the last European Union (EU) summit, and on recapitalizing its banks after asking for a credit line just for its financial sector. The source commented, “We have to respect the times, the rhythms. Spain sought aid for the banks on June 9 and we only signed the final agreement this week … The government is not looking at that [further rescue].”