It’s all looking a little sunnier in the eurozone what with the recent falls in borrowing costs for Spain and Italy. Are the black clouds drifting away?
Not quite. The big picture hasn’t changed much.
If anything, the latest data on unemployment and confidence (or lack thereof) suggests the growth outlook has gotten worse.
But it has been a decent few days for sovereign bonds. Spanish government’s borrowing costs and Italian yields are down on the back of comments made by Mario Draghi, European Central Bank president, which suggested the central bank could ramp up its crisis response at this Thursday’s governing council meeting of top central bank officials.
What were the magic words?
The words that made markets – and no doubt quite a few European politicians – leap for joy were these: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Significantly, the “believe me it will be enough” part was new.
Doesn’t sound like much.
It is if it comes from the head of the institution that holds the monopoly rights to printing euros.
Talk is cheap though. Will Draghi actually do anything?
In central banking, nuance matters and remarks are rarely off-the-cuff. Mr Draghi would not have stepped up the rhetoric unless he was intent on the ECB doing something.
There are a host of options.
Mr Draghi’s comments suggest the ECB is keen to take measures to counter the foreign exchange risk (ie, that the assets will no longer be euro denominated) inherent in the recent rise in governments’ borrowing costs.
The comments also highlight the ECB’s concern that its recent rate cuts have not been passed on to borrowers in peripheral countries such as Italy and Spain.
Few think a few bond purchases here and there will do the trick. But there other measures which could prove more effective.
One of the more extreme options would be for the ECB to set a limit on the gap between Germany’s cost of borrowing and that of countries such as Italy and Spain — a ‘Draghi put’ on peripheral sovereigns’ bond yields. It could also combine forces with the European Financial Stability Facility, the bloc’s temporary firewall.
Another potentially more significant, but in the near-term unlikely, option would be for the ECB to grant the European Stability Mechanism, the eurozone’s permanent bailout fund, a banking licence. This would multiply the ESM’s bond-buying capacity several times over the current €500bn limit, soothing fears the bloc lacks the resources to deal with a worsening of conditions in Spain and Italy.
However, Mr Draghi may not announce any game-changing measures on Thursday.
Germany’s Bundesbank last week reiterated its objections to more bond buying and the granting of a banking licence. Mr Draghi will meet Jens Weidmann, Bundesbank president, ahead of the meeting so Buba may come onboard.
Besides this, the ECB is also keen to keep the pressure on governments to act.
So are we going to see a big bazooka or pea shooter (hat tip to Paul Mortimer-Lee of BNP Paribas) later this week?
It’s difficult to tell.
Even if the governing council is not yet ready to unleash a big bazooka. we could see smaller steps such as a relaxation of collateral rules, or hints that further rate cuts – or more radical bond buying programmes — are on the way.
But, if that’s all Super Mario can offer, markets could well be left disappointed.