The ECB confirmed yesterday it agreed a new bond-buying programme aimed at the secondary market, to lower struggling euro zone countries' borrowing costs, through so-called “outright monetary transactions” (OMTs). There will be no limits on the size of such purchases, but they will be “sterilized”, meaning that (unlike in case of the Fed’s quantitative easing) for each euro created, a euro will be withdrawn from the system through taking deposits from banks. Bond-buying will be focused on the shorter part of the yield curve, in particular bonds with maturity of between 1-3 years.
A necessary condition for OMTs is conditionality attached to an appropriate EFSF/ESM programme, meaning the governments must first activate the programme for ECB to conduct bond-buying. The ECB said such programmes can take the form of: (1) full EFSF/ESM macroeconomic adjustment programme, or (2) precautionary programme called enhanced conditions credit line (ECCL). ECB underlined that IMF involvement will be sought for the design of conditionality and the monitoring of such programmes. The ECB will terminate OMTs once their objectives are achieved or when there is a non-compliance with macroeconomic programme. Importantly, the ECB also said it will drop seniority status on government bonds it buys under the new programme, a measure seen as critical to encouraging private bond investors. In Greece's debt restructuring earlier this year the ECB had preferred creditor status, therefore while private investors suffered a write-down in the value of their Greek bond holdings, bonds held by the ECB were not affected by the restructuring.
Apart from the bond-buying programme, ECB left interest rates unchanged at 0.75%, against expectations of a 25bp rate cut (according to Bloomberg survey), and in line with Reuters survey results. The ECB also presented its newest economic staff projections. As expected, growth forecasts were revised downwards and ECB now sees GDP in 2012 in a -0.6% to -0.2% range compared to -0.5% to +0.3% range in June. ECB projects GDP growth in 2013 in a -0.4% to +1.4% range vs. 0.0% to +2.0% range in June.
To sum up, the ECB confirmed yesterday it is ready to step in to help bring down the high borrowing costs of Spain and Italy intervening with unlimited, sterilized bond-buying, but it is the troubled countries that have to first ask for help through EFSF. The ECB’s statement and Q&A’s after the meeting were broadly in line with expectations and in line with the leaked draft obtained by agency Bloomberg on the day before. Still, the positive market reaction shows this was the information investors were waiting for and were satisfied to hear, especially after disagreements on the ECB Governing Council over the plan played out in public last week. In our opinion it is now likely Spain will request assistance from the EFSF when EU leaders meet in Cyprus on 14-15 September. The mere fact that Spain would requesting official help is negative, but such a move is necessary if the ECB/EFSF are to step in to help lower the country’s painfully high bond yields. In our opinion, the request might be conducive to stabilizing the markets’ perception of Spain and improving market