ECB rates unchanged; markets await word on bonds
Markets are now waiting to hear ECB President Mario Draghi speak at a news conference, where they hope he will give some sign that the bank will help lower the borrowing costs that threaten the finances of Italy and Spain by buying up government bonds in the open market.
Draghi sharply raised expectations last week when he said that the ECB would "do whatever it takes" to save the 17-country bloc that uses the euro and that "believe me, it will be enough."
Yet any effort to purchase bonds faces serious complications. An earlier effort bought over €210 billion in bonds, but did not decisively lower bond rates, or "yields", for troubled Spain and Italy. Germany's influential central bank, the Bundesbank, has expressed skepticism, saying the purchases could come too close to bailing out government finances — something the ECB's treaty forbids it from doing.
The decision to keep the key interest rate decision unchanged was largely expected — even though the eurozone economy is in a slump and a rate cut might have cheered markets as a sign the bank was willing to act. Analysts say, however, that a rate cut might have only limited effect on the economy since rates are already at a record low. Holding off on rate cuts also helps push indebted countries, including Spain and Italy, to continue cutting their deficits and reforming their economies.
Stocks across Europe were broadly unchanged following the announcement of the rate decision as traders waited for the start of Draghi's news conference.
The ECB had cut the refinancing rate only last month, on July 5, after cuts in November and December. The cuts lower the cost of credit to banks, businesses and consumers. But few are borrowing because of the slack economy and fear that worse may come.
High yields have driven Greece, Ireland and Portugal to take bailout loans from the other eurozone countries so that they could keep paying their debts, and Greece had to ask creditors to forgo €107 billion ($131.59 billion) in repayments.
Italy and Spain, both of which have to constantly sell new bonds to pay off old ones that are coming due, are now under similar pressure. But if these countries — the third- and fourth-largest governments in the eurozone respectively— find themselves locked out of bond markets by high yields, there are concerns that the eurozone's resources would be stretched close to breaking point if they asked for a bailout.
Draghi raised expectations when he said the bank could address those high yields — as long as they were preventing the low interest rates set by the ECB from spreading through the economy. If the bank was to move to help reduce borrowing costs, the economic uncertainty surrounding a country would ease off, helping it to get its finances under control.
However, Draghi has not said what the bank might do.
There are several possibilities but each has problems. One of the obstacles is that legally the bank cannot intervene in bond markets simply to make it easier for governments to borrow. Its founding treaty forbids it from using its monetary powers to finance the 17 governments in the eurozone.
It has bought bonds before in an intervention that started in May 2010 but that was stopped in March. Buying government bonds in the open market drives their prices up and interest yields down, since price and yield move in the opposite direction.
But that ECB bond purchase program didn't consistently drive down interest rates. That was because it was limited in amount and because criticism from German officials led markets to believe the ECB might not be unanimously behind it.
Other possible plans:
— Have the ECB buy bonds along with the eurozone's bailout fund, which could set tough terms for governments to get support, such as progress on cutting their debt and deficits.
— Letting the eurozone bailout fund borrow from the ECB, giving it more financial heft.
— Buying bonds so that they reach a fixed yield in the market. This would draw a line in the sand that could deter market selloffs of bonds.
— Giving up the ECB's status as a preferred creditor when it buys bonds. That status could be scaring off countries' other creditors, who might think there would not be any money left for them in case of a bond default.