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The European Central Bank will release its latest monetary policy decision tomorrow, and it’s likely to take some action to keep the financial system afloat for at least the next few month or so.A flurry of headlines recently suggest that EU leaders are working on some kind of grand plan to bring Spanish and Italian borrowing costs under control, but the time frame for such a project remains unclear.
Even so, our friend and Chief Europe Strategist at Trend Macrolytics tells us, there’s reason to believe that the ECB is not far from embarking on a sequence of measures that will ultimately renew faith in struggling sovereigns like Italy and Spain.
In particular, Draghi could announce that he wants all sovereign bond yields to converge to within 300-400 basis points (this number could vary) of the benchmark yields, those on German bunds. In other words, Draghi would announce the ECB’s intent to buy as many Spanish and Italian bonds as it would take to bring borrowing costs for both sovereigns closer together.
This would eliminate the disparity between German borrowing costs—at record lows—and Spanish and Italian borrowing costs, which are spiraling out of control. Adopting stronger crisis-fighting measures is currently to the detriment of the German, French, and other Northern European governments because those countries can borrow with unprecedented ease. This, then, is a barrier to progress across the pond.
ECB yield targeting would remove this roadblock, Roche Kelly reasoned. Germany and France would no longer have reason to oppose at least partial debt mutualization in eurobonds, diminishing tensions in financial markets.
Essentially, the ECB could single-handedly resolve the financial tensions of the crisis. Such actions are arguably within the central bank’s power, and a likely return to its bond-buying program is a strong step in the direction of yield targeting.
That said, Roche Kelly noted that the ECB will probably wait to do this until EU leaders have made more concessions that will resolve the lack of political, economic, and fiscal union in the eurozone. Those developments are key to making sure growth returns to the region.
We have one important problem with this plan: timing.
Germany has largely been able to avoid the ill effects of the crisis, with low unemployment and only a slight hit to GDP growth. Should the economic situation there deteriorate, however, that could ultimately be reflected in German yields. High yields converging could still lead to eurobonds, but doubts about the viability of all European sovereign debt would prolong the crisis.
Admittedly, the German economy might be able to carry the weight of Europe. However, rising yields on German bunds late last year suggested that Germany might not be quite as safe as investors would like to believe.