Waiting for Draghi

  • 6 September 2012
  • From the section Business
  • comments
Mario Draghi
Mr Draghi has promised, but how will he deliver?

Bad news: the next stage of the never-ending saga that is the eurozone crisis could depend on some arcane bits of monetary policy and some not very attractive words.

Mario Draghi will stand up this afternoon to explain how the European Central Bank's governing council has decided to back up his pledge to "do whatever it takes, within our mandate" to hold the single currency together.

Even more than usual, the markets will be focusing on the exact wording - and listening out for some key phrases, some of which are easier to understand than others.

When it comes to the ECB buying the debt of sovereign governments such as Spain, there are three pieces of terminology that matter today.

The first is whether they are "limited" or "unlimited". For reasons I've discussed before, the feeling is the ECB cannot be a real "lender of last resort" for the eurozone if it sets a limit to the amount of money it is going to spend reducing the borrowing costs of governments such as Spain.

A related question is whether the ECB will pledge to put a "ceiling" on these countries' borrowing costs - it might state, for example, that the interest rate they pay to borrow for one or three or even 10 years is being set unreasonably high by the markets, and will henceforth be kept below 5% or 6%.

The best bet is that the ECB will NOT make this last promise. It pretty much violates every rule in its monetary policy handbook.

However, it is possible that Mr Draghi will use the word "unlimited" in describing the new "monetary outright transactions" - the catchy new phrase they've come up with for the bond purchases. (Apparently none of them is destined for a career in advertising.)

That, they hope, will mark enough of a contrast with the previous programme of bond purchases, which stopped at the start of this year and were always described as "limited and temporary".

The second, equally unpleasant bit of terminology the markets will be looking out for is whether the purchases are going to be "sterilised" or "unsterilised".

To explain: if the purchases are sterilised, that means that every euro the ECB puts into the system buying government bonds will be offset by the ECB taking money out elsewhere, so the overall stock of money remains unchanged.

When a central bank such as the Bank of England buys government bonds as part of quantitative easing, it does NOT sterilise the purchases, because the whole point of QE is to get more money into the system.

The ECB might well undertake QE at some future date, to support the eurozone economy, but the betting is that Mr Draghi will NOT be announcing QE today.

If and when it buys bonds, Mr Draghi is likely to say that this is to improve the transmission of the ECB's existing monetary policy - making sure low interest rates get through to countries like Spain - not announce a new one.

Sterilisation also sends a signal to stalwarts at the Bundesbank and elsewhere that this is not - really not at all - about printing money to finance government deficits.

Finally, and crucially, the markets will be listening to hear whether the bond purchases are conditional. In fact, we already know the answer to this question, because Mr Draghi made clear last month that there would indeed be string attached to the new programme.

He said that any country hoping to benefit would need already to have applied for support from governments through one of the official rescue mechanisms - the EFSF or the ESM. And even then, the ECB would need to decide it was a good idea for the central bank to help.

The Spanish government didn't like that answer last month. I wonder whether it will feel any differently now.

A new bond purchasing commitment from the ECB today that was "unlimited, unsterilised and unconditional" would be the biggest shock for the markets.

Safe to say, that is not what we are going to hear. But governments across Europe will be hoping that Mr Draghi uses enough magic words to convince the financial markets that the ECB is willing to try something new.