Thursday, ECB President Mario Draghi announced a series of measures orchestrated to send a clear message to markets: The euro is here to stay. The measures shouldn’t be surprising to euro-watchers, who’ve repeatedly witnessed EU officials commit to “do whatever it takes to preserve the euro.” As we’ve often said, there’s no silver bullet to cure all that ails the eurozone. However, the measures announced aim to buy troubled peripheral nations still more time to right their fiscal imbalances and increase economic competiveness and productivity.
Draghi unveiled the ECB’s new bond buying program, Outright Monetary Transactions (OMT). The OMT was designed to replace the previous Securities Market Programme (SMP), which was effectively shuttered with this announcement. The OMT program, as its name implies, allows the ECB to openly buy sovereign debt in secondary markets (with durations of up to three years) with the aim of pushing down interest rates of the target country. However, to prevent stoking inflation (and raising the ire of the inflation-wary Bundesbank,) the ECB will sterilize any secondary market debt purchases by removing an equal amount of liquidity from circulation by offering banks interest on short-term deposits at the ECB. (Following the ECB announcement, the Bundesbank issued a statement of their own reaffirming their stance that ECB bond purchases amount to “financing states via the printing press.”)
Draghi also dispelled rumors of debt subordination—the ECB taking seniority in any debt purchases over private or other creditors. Following the Greek bond swap earlier this year, which made the ECB whole for its Greek debt holdings and forced many private creditors to take losses, some folks feared another ECB bond-buying program would be undermined by investors clamoring to shed the debt of any country that was party to it—negating its effectiveness. However, under the OMT, the ECB will be subject to the same losses (if any) as private creditors.
The program comes with some strings attached. Countries eligible to participate must tap the EFSF/ESM for aid and follow strict reform and austerity measures. Already bailed-out Ireland and Portugal will be allowed to participate when they fully regain access to credit markets. Countries failing to comply with targets would face “discontinuance of bond purchases” under the OMT. (Or, at least, so Draghi says now. We’ll see if his tune doesn’t change later.)
In our view, the terms of the OMT highlight Draghi’s second major message, “policy-makers in the euro area need to push ahead with great determination with fiscal consolidation, structural reforms to enhance competitiveness and European institution-building.” Reducing yields on sovereign debt for the troubled periphery likely eases funding concerns in the fore (if it works as planned). But this only buys time to iron out their various competitiveness issues. Some nations have more work to do on that score (we’re looking at you, Greece) and others, less (ahem, Ireland).