Draghi Says ECB Will Do What's Needed To Preserve Euro: Economy
Comment of the Day

July 26 2012

Commentary by David Fuller

Draghi Says ECB Will Do What's Needed To Preserve Euro: Economy

This forceful statement of intent fuelled today's sharp rallies in eurozone stock markets. Here is the opening:
European Central Bank President Mario Draghi said policy makers will do whatever is needed to preserve the euro, suggesting they may intervene in bond markets as surging yields in Spain and Italy threaten the existence of the 17-nation currency bloc.

"To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate," Draghi said in a speech at the Global Investment Conference in London today. "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro," he said, adding: "believe me, it will be enough."

Financial markets surged on speculation the ECB will act to lower Spanish borrowing costs after yields on the nation's bonds rose to levels that prompted bailouts for Greece,Portugal and Ireland. The ECB reluctantly started buying Spanish and Italian debt in August last year as part of its bond purchase program. The buying had little lasting effect and the ECB suspended the program in March.

"His comments certainly suggest that ECB purchases of Spanish and Italian bonds are back on the table for discussion," said Chris Scicluna, head of economic research at Daiwa Capital Markets Europe. "But -- just like last summer -- we would expect any new ECB bond purchases to be temporary and limited until other policies are put in place."


Draghi has swollen market expectations before.

On Dec. 1 last year, he appeared to suggest to the European Parliament that the ECB would ramp up its government bond purchases if European leaders agreed on the then-novel idea of a fiscal compact.

Italy's 10-year bond yields fell 37 basis points after those comments, only to rise 44 basis points a week later when Draghi downplayed the speculation. The ECB subsequently implemented two three-year loan programs that pumped more than 1 trillion euros into the financial system, helping to ward off a credit crunch.

Draghi said today that markets have underestimated the progress that's been made in the euro area and that the monetary union is "irreversible." Leaders have this year inked agreements that aim to push the single currency toward tighter joint budgetary surveillance and a so-called banking union.

"The progress in undertaking deficit control, structural reforms has been remarkable," Draghi said. "They'll have to continue doing so, of course, but the pace has been set."

David Fuller's view The market crowd has its financial hyenas. Most are hyena cubs but some are powerful, and they hunt in packs. As in any jungle, the financial hyenas like nothing more than a wounded beast. The eurozone has provided hyenas with a herd of wounded beasts after more than a decade of self-inflicted wounds. And the financial hyenas have feasted.

European Central Bank President Mario Draghi understandably wants the eurozone's wounded beasts to recover. He believes that his financial ministrations, including lots of euro transfusions, will be more effective if he can scatter the financial hyenas from time to time. He may not prevent them from isolating Greece but he needs to see Spain and Italy back on their feet, sufficiently recovered so that the financial hyenas look elsewhere for easy prey.

It is a difficult task as everyone watching this absorbing drama knows. Nevertheless, Mario Draghi is probably the only European genuinely feared by the financial hyenas. The ECB President knows this and he roared today, as much as a studious central banker can roar, as you can see in that opening quote in the article above.

The hyenas have retreated today, as you can see from these upward dynamics for the Spanish and Italian stock market indices, no doubt produced mainly by short covering. The euro is also firmer today, having steadied above the psychological €1.20 level versus the US dollar. These chart patterns look temporarily oversold but show little support in the form of base building at this time to sustain more than a technical rally.

A number of commentators see the eurozone's problems as insurmountable. They point out that debt hangs over the region like a poisonous mantle and there is no credible plan for jumpstarting GDP growth. They maintain that heavily indebted economies, and not just in the eurozone, should be allowed to collapse, with their debts written off, as a prerequisite to a sustainable recovery.

History may be on their side but politicians and central bankers are following a different path. It may take longer and much of the debt will be monetised but I do not see Spain and Italy's debt problems as insurmountable. Additionally, I would not underestimate Mario Draghi, now that he is acting as lender of last resort.

Meanwhile, this assessment by Matthew Philips for Bloomberg Businessweek: Will Draghi Put His Money Where His Mouth Is? - summarises both the scepticism and the ECB's problems, not least the ballooning balance sheet.

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