Headlines generated by some promising statements from European Central Bank President Mario Draghi late last week have stirred investor belief that European leaders—and in particular the ECB—are about to announce some game-changing crisis-averting measures. Such action could happen as early as Thursday, when the ECB makes its latest monetary policy decision.
Draghi told reporters in London that the ECB would “do whatever it takes to preserve the euro,” qualifying that the central bank was subject to the restrictions of its mandate.
Investors immediately believed that the ECB would restart a controversial bond buying program (SMP) intended to push down the cost of borrowing for the Italian and Spanish governments. But reports from French newspaper Le Monde (amid other public statements from EU officials) suggest that European leaders will also make a move, perhaps to supplement ECB bond-buying with similar action from the European bailout fund (EFSF).
By all indications, some new plan is indeed in the works. A Draghi visit to the German Bundesbank—which has publicly argued against bond-buying from the ECB—suggests that the Italian Draghi is preparing to strong-arm the German Bundesbank into some steps the latter won’t like. Promises from Eurogroup president Jean-Claude Juncker over the weekend affirmed the idea that EU leaders will make monumental decisions in the next few days.
That said, it would appear that investors have forgotten EU leaders propensity to disappoint. Numerous EU leaders have criticised the ECB bond purchase program for its ineffectiveness in the past, and there’s little likelihood that bond-buying (except on a massive scale) would have anything but a temporary effect.
That’s because these purchases happen on the secondary market, meaning that investors will still control the price at which Spain and Italy can borrow in the primary market.
rumours that the EFSF could buy bonds directly from Italy and Spain, therefore controlling the cost at which they can borrow, are more compelling, as they would signal common willingness to take more action. However, the fact that the EFSF’s funds are limited—and the likelihood that an attempt to amass more funding from EU countries will be a political nightmare—suggests that any plan led by common EU leadership will fall short.
Considering how far yields (a proxy for cost to borrow) on Spanish and Italian two-year bonds have fallen in the last week, investors are likely too enthusiastic about the prospect of action.
A June EU summit produced a rare upside surprise, but disappointments are far closer to the norm.