MORGAN STANLEY: The ECB's New Plan Is 'Quite Likely' To Deepen Europe's Recession

Dark clouds

Photo: taigasylvan on Flickr

Markets soared after the ECB announced its new bond-buying plan yesterday. Many Wall Street strategists have expressed cautious optimism since ECB President Mario Draghi revealed the details of the rescue program designed to bring government borrowing costs down in Italy and Spain.Morgan Stanley rates strategist Laurence Mutkin is one of them – at least, for now. In a note today titled OMT – OMG!Mutkin wrote that the ECB’s new plan provided “ample firepower” to bring down yields in Spain – pretty much as far as the ECB would like – but only for a spell.

Mutkin also told clients that in the long term, it’s “quite likely” that the “outright monetary transactions” (OMT) announced by the ECB yesterday will be remembered as another terrible idea conceived by the European institutions tasked with quelling the euro crisis.

As such, the OMT will probably deepen the recession in Europe, according to Mutkin:

The paradox of sovereign thrift

Certainly, the near-term outlook for peripheral bond yields is greatly improved by the instigation of the OMT. But we are concerned that, taken as a whole, the architecture surrounding the OMT programme is pro-cyclical and therefore potentially self-defeating.

The prior condition for activation of OMT is entry into an EFSF/ESM programme. If the past is any guide, this will require further fiscal austerity. Such a pro-cyclical policy – again, if experience is a guide (eg Portugal, Greece) – is quite likely to deepen recession and so worsen the fiscal sustainability of the country affected, in our opinion. A (perhaps exaggerated) way of putting it would be to say that the pre-condition for OMT assistance would be to sign up for a plan that mandates a “fiscal cliff”, of the type investors are so keen to see the US avoid.

Requiring fiscal austerity by every euro-sovereign with economic prospects so weak would also reduce growth prospects for the eurozone economy as a whole, amounting to what Keynes called the Paradox of Thrift, but on a sovereign level.

So the risk is that the OMT package, taken as a whole, would appear to hold longer-term dangers for sovereigns, even though it’s undoubtedly good news in the nearer term.

Certainly the OMT and its surrounding architecture, while a great step towards repairing the monetary transmission mechanism, is not in itself an economic stimulus measure. The economic outlook will remain grim, in our opinion, keeping duration assets well supported.

That doesn’t sound good.


  • BARCLAYS: The ECB May Not Have To Buy Much Spanish Debt After All >
  • NOMURA: Our Incredibly Bearish Take On Why The ECB Only Bought 3 Months At Most >
  • CITI: How The ECB’s New Rescue Plan Could Go All Wrong >
  • JP MORGAN: The ECB’s New Plan Will Change The Course Of The Euro Crisis >
  • GOLDMAN: Spain Will Formally Request A Bailout Next Weekend >
  • BofA: More Bad Than Good Came Out Of The Big ECB Announcement >

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