Tuesday 19 November 2019

Brendan Keenan: ECB wields a big stick but cannot save euro on its own

SPEAK softly and carry a big stick, was President Theodore Roosevelt's advice for international politics.

President Mario Draghi of the European Central Bank has been talking increasingly strongly, but there have been doubts about the size of the stick.

Yesterday, Mr Draghi showed more of the weapon to a waiting world. In theory the ECB, like any central bank, can wield a very big stick indeed. It can create unlimited amounts of money but, used carelessly, that can do damage all over the place.

The key point for many in yesterday's ECB statement was that there is no limit to the amount the ECB is willing to spend buying the debt of governments it thinks need and deserve such assistance. The ECB will, to quote Mr Draghi, "do whatever it takes".

The problem is when, and how. Hard-pressed Irish borrowers, represented yesterday by the Irish Professional Brokers' Association, might have preferred the ECB to cut its interest rates. It did not do so, and gave no signal of an early cut to the US and UK levels of half a per cent, from the present three-quarters.

But the bond-buying programme is designed to reduce the actual interest rates that people pay, rather than the ECB rate, which only applies to banks. Indeed, the ECB's argument for producing the big stick is that a single currency is not working if borrowers in Ireland are paying 5pc for loans, while those in Germany pay 3pc. Imagine if it were Cork and Donegal.

We all know the reasons, but the ECB is now openly saying that the fear of the euro breaking up is a major factor behind those differences. As guardian of the euro it feels entitled to do something about it.

Governments pay a fixed sum, such as €5 per year on every €100 bond sold. If the ECB thinks that 5pc rate is too much, it can buy the bonds at €125 which, in this simplified case, turns the €5 payment into a yield of 4pc. The idea is that the government can then borrow new money at a rate close to 4pc, because the ECB is willing to buy its bonds at that price in the market.

The ECB will buy bonds at a price which keeps the interest rate down to what it regards as a reasonable level. It won't say what that level is, but the markets have been putting their own price on it. The yield on Spanish bonds repayable in 2014 has fallen to 3pc, from 7pc before the talk of ECB intervention, while the Italian equivalent dropped to 2.45pc from 4pc. It would be surprising if the ECB wanted them to go higher.

With the guarantee of an ECB minimum price, the hope is that Spain (it is all about Spain in the first instance) can borrow at affordable rates in the market, and avoid having to seek essential funds through a full-scale EU/IMF bailout.

A Spanish bailout would test the rescue mechanism to the limit. An Italian rescue is impossible, because of the size of the Italian bond market. It is not going too far to say that this has to work if the euro is to have any chance of survival.

There is an important bit for Ireland. Mr Draghi confirmed that bond support could be made to help countries coming to the end of a bailout. If they are in good enough shape to return to the market at all, the ECB could ease their passage by keeping borrowing costs down.

That is an incentive for the Government to keep trying to get into that shape. In particular, it must seek to meet the target of balancing tax revenues and public spending by 2014. Even Greece is expected to have achieved that by next year.

Incentives are the big problem about turning the theory behind the plan into successful practice. As Health Minister James Reilly can testify, only the imminent threat of something worse can persuade people to accept the kind of cuts and taxes needed to fix gaping holes in the public finances.

The troika can threaten not to pay the wages next month. Now the ECB can threaten to stop buying bonds. To get ECB support, countries have to tap the EU rescue funds first, and agree to conditions similar to those in a bailout. If they fail to meet the conditions, the ECB can stop buying their bonds.

The flaw is obvious. As with Greece, any actual withdrawal of support could lead to financial mayhem and debt default in the country involved, general panic elsewhere, and perhaps the break-up of the euro.

One analyst likened it to the Monty Python bankrobber threatening to shoot himself if the teller did not hand over the money. This is the root of the German fear that, rather than a stick, the plan resembles a carrot encouraging the Spanish or Italian governments to ease up on "austerity".

It was significant though, that there was only one formal objection to the plan in the ECB Governing Council. It can be safely assumed that came from the German Bundesbank's Jens Weidmann. Other hawkish central bankers, such as those of Finland and the Netherlands went along, while Chancellor Angela Merkel gave it clear backing.

That is unity of a sort, but one thing all agree upon is that the ECB cannot save the euro on its own, no matter how much money it "prints".

Equally dramatic actions are required from governments. As the latest ECB forecasts show the eurozone economy shrinking this year, and stagnant in 2013, politicians must finally demonstrate that the euro is a collective currency, not a shared one.

Irish Independent

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