Bank's Italy bond buying eases one problem, inflames another
The European Central Bank's foray into Italy's bond market has eased one immediate problem but exacerbated another: it is now in full-blown conflict with the Bundesbank, its biggest constituent.
The ECB's move on Monday to buy Italian and Spanish sovereign bonds saw the bank depart further from its core task of delivering price stability in the 17-country euro zone.
The intervention, agreed during a conference call late on Sunday, was a watershed moment for the young central bank after modest bond-buying of smaller peripheral country debt last week failed to stem contagion of the euro zone debt crisis.
Former ECB chief economist Otmar Issing told Reuters earlier this year that in buying the government bonds of Greece, Portugal and Ireland the ECB had "crossed the Rubicon." The Rubicon is now some distance in the bank's rear view mirror.
For Bundesbank chief Jens Weidmann, the most powerful of the national central bank chiefs on the ECB's Governing Council, this is all wrong.
Like his predecessor Axel Weber, who quit after publicly opposing the ECB's decision in May last year to buy bonds, Weidmann feels the central bank should focus on fighting inflation rather than influencing governments' borrowing costs -- a business that for him strays too close to fiscal policy.
So while the intervention has brought down the yield on Italian and Spanish bonds, it has left Jean-Claude Trichet with a rift to heal on the ECB's Governing Council before he hands over the bank's presidency to Mario Draghi in three months.
"Unless they have mysteriously resolved all the discord overnight, this looks like the most serious disagreement since the ECB was set up 13 years ago," said David Marsh, co-chairman of think tank OMFIF.
Intervening in the Italian bond market is a very different game from doing the same with Greece, Portugal and Ireland.
The euro zone's third largest economy, Italy has one of the world's highest levels of public debt -- around 120 percent of gross domestic product.
The size of the ECB's intervention on Monday alone shows the scale of the task it has undertaken -- traders said the central bank bought some 2 billion euros of paper. The last time it bought that much in a whole week, let alone one day, was in January of this year.
Unlike Weber, whose public criticism of the bond-buy plan saw him become isolated on the 23-member Governing Council, Weidmann has support. He and three others opposed the reactivation of the programme last Thursday, central bank sources told Reuters.
To make a real, sustained impact with the intervention in Italian and Spanish bond markets, the ECB needs to convince markets it means business. The opposition from the four dissenters makes this tough.
RBS economist Jacques Cailloux said the ECB's acquisition of Greek, Portuguese and Irish bonds showed "the ECB can take a decision and implement that decision even if the Bundesbank does not share that view."
"But it will have to gain confidence from the market, to show that this is not an issue, that's the problem," he added.
The ECB decision to buy the bonds of Italy and Spain was couched in a statement that lacked any sense of 'shock and awe', and which appears to have reflected the split on the Governing Council.
The ECB buried a vow to "actively implement" the program at the bottom of the document and included a caveat reading:
"This program has been designed to help restoring a better transmission of our monetary policy decisions -- taking account of dysfunctional market segments -- and therefore to ensure price stability in the euro area."
That smacks of the Bundesbank's inflation-fighting instinct.
The statement was also issued in Trichet's name, unlike the ECB's announcement in May last year that it was beginning the program, which was in the name of the whole Governing Council.
The market reaction to the ECB's intervention will be crucial to determining its appetite for buying more bonds.
"If the ECB is forced by market tensions to remain in the market and continue buying, then this division might become a problem," said Peter Vanden Houte, economist at ING.
"Sooner or later, this minority will become bigger and the ECB could decide they don't want to fill their balance sheet with Spanish and Italian bonds."
Trichet, who prepared for Sunday's crucial ECB meeting alone at a Frankfurt cafe, managed to persuade the bank's 23-man Governing Council into agreeing to expand the bond-buying plan after a crucial signal from the leaders of France and Germany.
Their focus in a joint statement on the euro zone rescue fund's ability to buy government bonds once the bloc's parliaments have ratified its new powers was meant to encourage the ECB to do the same in the interim.
German Chancellor Angela Merkel and French President Nicolas Sarkozy said they were committed to getting approval from their parliaments for new powers for the European Financial Stability Facility (EFSF) rescue fund by the end of September.
Getting the EFSF to buy bonds from September in place of the ECB could help Trichet paper over the rift with Weidmann. But to resolve the conflict, the EFSF could pick up the tab for the ECB's bond purchases.
"The best way to resolve the disagreement would be for the ECB to make clear that it is acting for the account of the EFSF and the sovereign governments that stand behind it and in this way will be indemnified for any losses that arise from purchasing bonds that subsequently lose value," said Marsh at the OMFIF think tank.
"If this is the case, then this would give the ECB the necessary protection -- and the ECB should make every effort to clarify the situation."
[Source: By Paul Carrel, Reuters, Frankfurt, 09Aug11]
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