Mario Draghi has spoken.
And the markets haven’t collapsed, at least, which will no doubt be a relief to the European Central Bank (ECB) head.
The ECB kept interest rates on hold, but this was a sideshow. The big news was always going to come from the press conference afterwards. As was widely expected, Draghi confirmed that the ECB would buy an “unlimited” amount of government bonds via Outright Monetary Transactions (OMT) – but this depends on the ‘fiscal pact’ and the European Stability Mechanism (ESM – the big eurozone bail-out fund) being agreed.
As I’ve already noted, that puts the ball firmly in Germany’s court (literally) next week.
Draghi also stated that in return for any bond-buying assistance from the ECB, countries would have to agree to carry out economic reforms and to keep to fiscal targets.
To make the threat credible, the ECB will stop buying the bonds of any country that doesn’t deliver. He also emphasised that the debt purchases would focus on short-term debt, and would not include an explicit cap on yields.
Finally, any bond-buying will be sterilised, so the ECB will fund it through selling debt to the markets. The point of doing this is to avoid expanding the money supply, and therefore ease concerns about the bond-buying creating inflation.
The ECB Paves the Way to Print Money
The euro slid, then clawed its way back, as markets digested the news. However, Italian and Spanish stocks rose strongly. In part this is a reflection of the ambiguity.
On the one hand, “unlimited” support implies that the ECB’s purchases could be large. However, by refusing to put a clear cap on yields, the ECB action could just as easily end up being very small.
There are also concerns that the need for countries to agree to fiscal and policy conditions will delay bond purchases.
Certainly, if the ECB keeps to the letter of its promises, it will be very hard for it to take the action needed to keep the euro together. The need for the ESM to be approved, for a start, means that any action may be delayed for a month or two at the earliest.
The fact that the German member of the ECB also opposes the action taken suggests that Draghi will have to proceed with caution. Indeed, the German economic ministry immediately stated that bond-buying by the ECB can’t be a substitute for reforms.
However, the fact that bond-buying has been agreed at all is an important step. Once started, it is hard to see how it can now be stopped. Either the ECB prints a large amount of money, or the euro breaks up – in which case, the national banks will almost certainly step into the breach.
Indeed, the only downside fear is the ‘Hotel California’ scenario. In this case, the ECB would buy enough bonds to keep the euro together, but not enough to deliver a major economic boost. However, as we’ve said, the decision by the German Constitutional Court on the constitutionality of the ESM, expected next week, may force the ECB to become even more aggressive.
Stick with European Shares
It’s worth at least drip-feeding money into Europe. Stocks are cheap, and Draghi has shown a commitment to avoid letting Italy or Spain go bust.
Another way to take advantage of the coming money-printing is to buy gold. As we’ve said before, in the past it has proven to be among the best hedges against the inflation that is likely to result from bond purchases.
And it’s always useful to have in your portfolio in case all this experimental policy by central banks goes horribly wrong at some point in the future.
Matthew Partridge
Contributing Editor, Money Morning
Publisher’s Note: This article originally appeared in MoneyWeek
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