European Central Bank President Mario Draghi has unveiled a long-awaited program to buy up bonds and help bring down the borrowing costs of Europe’s struggling governments.
The plan envisions no set limit on the amount of bonds the ECB could buy, making the program “a fully effective backstop” against a further worsening of the debt crisis in the 17 countries that use the euro.
The initiative — dubbed Outright Market Transactions or OMT— goes beyond an earlier, limited bond purchase program that was not big enough to decisively lower borrowing costs.
Draghi emphasized that the new, unlimited program by contrast was open-ended and had “no quantitative limits.” He said it would work because it was “very very different from any program we have had in the past. “ The new program would continue until its goal of lower borrowing costs is achieved, or a government violates the conditions attached to getting the help.
Markets remained buoyant Thursday as investors cheered the ECB’s package of measures. In Europe, Germany’s DAX was up 2.1 % at 7,113 while the CAC-40 in France surged 2.3 % to 3,484. The FTSE 100 index of leading British shares was 1.2 % higher at 5,728.
“The ECB did not disappoint in its decision to start a vast bond purchase programme,” said Marie Dimon, senior economic adviser at Ernst & Young
Bond purchases push bond prices up and interest yields down, since price and yield move in opposite directions. Governments can then take advantage of the lower yields when they borrow. Countries must constantly borrow by selling new bonds to pay off old ones that are coming due. If rates rise too much, it can make it impossible for the country to maintain its debt burden. That’s what forced Greece, Ireland and Portugal to seek bailout loans from other eurozone countries.
Spain and Italy are in the same difficulty now, with Spain paying more than 6 % on 10-year borrowing and Italy more than 5 %. The fear is that they are too large to bail out, and that a failure to pay their debts could trigger financial turmoil that could break the eurozone apart and disrupt the global economy.
Following Thursday’s announcement, Spain’s interest rate on its 10-year bond was down 0.3 % on the day at 6.09 %, while Italy’s 10-year rate was down 0.18 % at 5.25 %.
A key feature of the OMT is that countries that want the ECB to buy their bonds must first officially ask for help from Europe’s bailout funds and agree to “strict and effective” budget policy conditions. That is to ensure they won’t relax their efforts to reduce deficits once the bond purchases take the financial pressure off them.
The ECB said the International Monetary Fund — which has long experience pushing governments to stick with loan conditions — should be involved in enforcing conditions.
Some analysts believed the OMT program unveiled Thursday would not solve the underlying problems in the eurozone, however. “Without trying to be a ‘party pooper’,” said Neil MacKinnon, global macro strategist at VTB Capital, “suppressed borrowing costs certainly provide relief in the short term but do not resolve problems of solvency and debt unsustainability.”