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All the buzz today is about the report in German magazine Der Spiegel about the ECB setting a hard cap on peripheral yields, or at least spread relative to German yields.This is causing a big drop in Spanish short-term borrowing costs.
In a note, Nomura’s Jacques Cailloux gives four reasons to be sceptical that the ECB will do something massive.
He cites four impediments:
- The ECB is guided by conditionality. There’s no way the ECB will just come in and reduce yields across the board without the recipient countries agreeing to oversight and reforms.
- The ECB has already said it will only intervene on the short term. Thus hard caps across the yield curve are unlikely.
- A spread target may not be that helpful if German yields rise significantly. The target makes more sense if its a yield target.
- It’s not clear how the ECB would set the spread for each country. “We believe that identical and unconditional yield targets across member countries are currently impossible to fathom. In fact, it is likely illegal under the treaty.”
So what is possible:
Overall, as we noted above, we do not believe the ECB is about to embark upon unconditional yield targets across all euro area countries. The only feasible option in the short term, in our view, would be to specify its intervention modus operandi for countries requesting help such as Italy and Spain. We believe this is very likely to take place at the September meeting (as hinted at by Asmussen‟s interview in Frankfurter Rundschau this morning).
In this context, one could imagine the ECB targeting a yield at the short end of the curve in both Italy and Spain once they have requested help (or any country that requests help through the EFSF/ESM in the future), most likely by guiding market expectations through its intervention, rather than publishing an explicit yield target. The key question remains how low the ECB will go in terms of yield levels at the short end. Assuming the ECB intervenes on the ground that the transmission mechanism is broken, it is easy to conceive a situation where the ECB would try to guide expectations on the very short end (perhaps up to one year) to as close as possible to the refi rate. This would, in a sense, result in the return of the one-size- fits-all policy with a unique policy rate for every member country. Of course, the difficulty here is that, by announcing that the intervention would only take place in countries that signed MoUs, fully restoring the transmission mechanism across all countries would be difficult under the terms sketched out two weeks ago. In a sense, intervention on the very short end across all member countries would be akin to the creation of Eurobills. These were part of the discussions at the last EU summit and might still gain traction in the coming months, but again, conditionality seems to be part and parcel of such a new policy instrument.