After several failed attempts to rein in the yields on the peripheral government bonds, the European Central Bank (ECB) is back again. This time with Outright Monetary Transactions (OMTs). But can OMTs achieve what other programmes couldn’t? B&E talks to a host of experts, including the ECB President Mario Draghi, to find the answer.
The summer of 2012 was somewhat depressing for countries across the eurozone until European Central Bank (ECB) President Mario Draghi announced he was willing to do “whatever it takes” to keep the single-currency union intact. And he had reasons for it. The eurozones’s economy was (it still is) under tremendous pressure from a credit crunch, and as such fiscal tightening. While the economy had contracted for the second time in a year (Eurozone’s GDP declined 0.2% in Q2 2012 after stagnating in Q1 2012), the composite PMI for manufacturing and services had fallen in July to its lowest level in more than three years (since June 2009). Even the number of people out of work in the region was up by 88,000 to 18 million in July. Although the statement, from the head of the most important financial institution in Europe, was enough to ignite some sparks of optimism, no one had a clear idea of what Draghi really had in mind.
Come September, Draghi has finally explained what he meant; the ECB would now engage in what it calls “outright monetary transactions (OMTs),” unlimited purchases of government bonds for eurozone countries near the brink of financial crisis. With this new intervention programme – termed as European Stability Mechanism (ESM) – the central bank aims at “preserving the singleness of its monetary policy and to ensure the proper transmission of its policy stance to the real economy throughout the region.”
Interestingly, the ECB was engaged in open-market operations a year ago as well, purchasing Italian and Spanish sovereign debt, but it couldn’t achieve much out of it. Yields declined temporarily, but later rose to new heights. For instance, the yield on Spain’s 10-year government bond had again reached 7% (in January 2012), the level that prompted Greece and Portugal to seek help from ECB, after it was driven back under 6% by ECB’s bond-purchase programme in September last year. Result: The ECB purchases were essentially stopped in January 2012, replaced by two so-called long-term refinancing operations (LTROs), which boosted liquidity in the eurozone via €1 trillion in three-year loans to banks. The loans indirectly eased pressure on governments by allowing banks to buy more sovereign debt. Yet interest rates for the debt of fiscally troubled eurozone countries remained stubbornly high. Thus, the question remains: Can OMTs achieve what LTROs couldn’t?
What ECB now plans is a more direct action to keep those borrowing costs down, using open-ended purchases of short-term government bonds in the secondary markets. In fact, as a bondholder, ECB will not claim seniority over other creditors. It will also ignore potential credit downgrades by rating agencies and will not demand more collateral if that occurs. The reason is simple. Financial market fragmentation and the uneven supply of credit across eurozone are holding back growth, effectively delaying a resolution of the debt crisis. Agrees Mario Draghi, President, ECB, as he tells B&E, “Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.”
The summer of 2012 was somewhat depressing for countries across the eurozone until European Central Bank (ECB) President Mario Draghi announced he was willing to do “whatever it takes” to keep the single-currency union intact. And he had reasons for it. The eurozones’s economy was (it still is) under tremendous pressure from a credit crunch, and as such fiscal tightening. While the economy had contracted for the second time in a year (Eurozone’s GDP declined 0.2% in Q2 2012 after stagnating in Q1 2012), the composite PMI for manufacturing and services had fallen in July to its lowest level in more than three years (since June 2009). Even the number of people out of work in the region was up by 88,000 to 18 million in July. Although the statement, from the head of the most important financial institution in Europe, was enough to ignite some sparks of optimism, no one had a clear idea of what Draghi really had in mind.
Come September, Draghi has finally explained what he meant; the ECB would now engage in what it calls “outright monetary transactions (OMTs),” unlimited purchases of government bonds for eurozone countries near the brink of financial crisis. With this new intervention programme – termed as European Stability Mechanism (ESM) – the central bank aims at “preserving the singleness of its monetary policy and to ensure the proper transmission of its policy stance to the real economy throughout the region.”
Interestingly, the ECB was engaged in open-market operations a year ago as well, purchasing Italian and Spanish sovereign debt, but it couldn’t achieve much out of it. Yields declined temporarily, but later rose to new heights. For instance, the yield on Spain’s 10-year government bond had again reached 7% (in January 2012), the level that prompted Greece and Portugal to seek help from ECB, after it was driven back under 6% by ECB’s bond-purchase programme in September last year. Result: The ECB purchases were essentially stopped in January 2012, replaced by two so-called long-term refinancing operations (LTROs), which boosted liquidity in the eurozone via €1 trillion in three-year loans to banks. The loans indirectly eased pressure on governments by allowing banks to buy more sovereign debt. Yet interest rates for the debt of fiscally troubled eurozone countries remained stubbornly high. Thus, the question remains: Can OMTs achieve what LTROs couldn’t?
What ECB now plans is a more direct action to keep those borrowing costs down, using open-ended purchases of short-term government bonds in the secondary markets. In fact, as a bondholder, ECB will not claim seniority over other creditors. It will also ignore potential credit downgrades by rating agencies and will not demand more collateral if that occurs. The reason is simple. Financial market fragmentation and the uneven supply of credit across eurozone are holding back growth, effectively delaying a resolution of the debt crisis. Agrees Mario Draghi, President, ECB, as he tells B&E, “Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.”
For More IIPM Info, Visit below mentioned IIPM articles
Professor Arindam Chaudhuri – A Man For The Society….
IIPM: Indian Institute of Planning and Management
IIPM makes business education truly global
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
| ExecutiveMBA |
