Der Spiegel: - As part of its efforts to fight the euro crisis, the European Central Bank (ECB) is considering establishing caps on interest rates for government bonds in individual countries as part of its future bond-buying program. Under the plan, the ECB would begin purchasing government bonds from crisis-hit countries if yields for those bonds exceeded the interest rates for benchmark German sovereign bonds by a predetermined amount. This would signal to investors which interest rate levels the ECB believes to be appropriate.While the response to this proposition has been appropriately positive, it appears many have forgotten that Draghi effectively laid out this plan in his “big” speech a few weeks back. At that time, there was a general feeling that the ECB was undergoing a philosophical change that included a willingness to eliminate the solvency and redenomination concerns (a power it holds as monopoly supplier of the currency).
My reaction at that time was a little less sanguine (my emphasis):
Whether or not these “philosophical changes” ever become reality remains an open question, but the ideas of renouncing seniority and leaving QE open-ended are clearly a step in the right direction. That being said, Draghi maintains the ECB’s position that further action is conditional on fiscal consolidation and structural reform. In this more important sense, the ECB’s philosophy has not really shifted at all.Once again, I get the distinct impression that many pundits are overlooking the critical factor that the ECB will not act unconditionally. Doing so would practically eliminate the ECB’s leverage in ensuring compliance with the Maastricht treaty and reaching their desired ends.
These recent “open mouth operations” by the ECB have once again bought time for Europe to come up with a grand resolution. It seems these actions have also provided the peripheral governments (especially those in Spain and Italy) with a bit more bargaining power. A game of chicken may now ensue between Spain/Italy and the ECB to see which side blinks first. Will Spain and Italy accept fiscal consolidation and structural reform in return for a guaranteed cap on yields? Or will the ECB be forced to intervene before those conditions are accepted? And how long will markets remain complacent without any actual action?
Those are the important questions that came to my mind following the Der Spiegel report. My best guess is that markets will once again force the hand of politicians and central bankers. Although I believe the ECB would blink, if politicians stand strong, I doubt it will come to that. Therefore, solvency and redenomination concerns will be erased, while economic stagnation continues. Whether or not that status quo can be maintained politically remains an open question....