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European Central Bank ‘may’ act

By Sheyna Steiner · Bankrate.com
Thursday, August 2, 2012
Posted: 11 am ET

The European Central Bank met this week and disappointed global markets by not launching a bond buying program and leaving interest rates at the level set in July. The central bank may design a bond buying program with an eye toward pushing down borrowing costs -- if conditions are met by governments of European nations, Mario Draghi, president of the European Central Bank, announced in his statement following the meeting.

After dropping the key interest rate 25 basis points last month, to 0.75 percent, the governing council of the European Central Bank, or ECB, decided to keep rates unchanged at this week's meeting.

There were widespread expectations that the ECB would undertake a bond buying program as a result of a speech given in London last week by Draghi. However, he announced, there were conditions that must be met before they can undertake a program that would push bond yields down in struggling countries Spain and Italy.

Before the central bank can act, governments must live up to their promises to the European Financial Stability Facility, or EFSF, and the European Stability Mechanism, or ESM.

The EFSF was designed as a bailout fund for struggling eurozone countries in 2010. The ESM was planned to be a permanent bailout fund, the details of which are still being hashed out.

In today's statement, Draghi pushed on eurozone governments to get the ESM in order and to be ready to activate the EFSF/ESM when needed. The bailout fund could also buy sovereign bonds in an effort to keep yields down but that comes with complications, for instance, the government of the country would have to formally make the request and help would come with strings attached, according to a story from Bloomberg.com today, "ECB keeps rates as Draghi pressured to bring down yields."

From the statement released after this week's meeting:

The adherence of governments to their commitments and the fulfillment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further nonstandard monetary policy measures according to what is required to repair monetary policy transmission.

Draghi did not specify what the nonstandard policy measures could be, but he did indicate that any open market operations would focus on bonds on the short end of the yield curve.

"The main reason is that it falls squarely in the list of the classical monetary policy instruments. The shorter is more close to money market operations," he said in the press conference following this week's meeting.

It's also unclear how the ECB will work with, or around, the ESM and EFSF which only offer aid with strict conditions.

"The head of the ECB, Mario Draghi, laid out a firm commitment to do more to ease the upward pressure on bond yields in Europe's Southern periphery during his press conference today, but then he undermined that commitment by failing to say how or when the ECB might engage in those operations," says Diane Swonk, chief economist at Mesirow Financial, in a blog post covering the press conference.

"Buying bonds of countries with low credit ratings could expose European taxpayers to losses that Germany, in particular, has been unwilling to accept. It also is closer to fiscal policy than monetary policy, which has caused deep divisions within the ECB," she says.

A speech in London last week gave markets the impression that a bond-buying program was imminent but today Draghi said that impression was mistaken.

"If you have read the speech there is no reference to a bond buying program. I can't make what the media writes. (The speech) doesn't say anything about timing, bond buying. The tone was strong but the stance was an affirmation that the euro area is a strong place in the world and the euro is a strong currency and is irreversible," he said in today's press conference.

Some analysts and pundits have speculated that there may be a bond buying program launched in coordination with the Federal Reserve in coming weeks.

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