Euro breakthrough? Draghi set to offer 'unlimited' bond buying

Sep 6, 2012

But there will be strings attached when European Central Bank boss unveils his plans today

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EUROPEAN Central Bank President Mario Draghi is set to unveil plans today to buy sovereign bonds of troubled member states. Details leaked to Bloomberg News outline a scheme in which central bankers will be able to make "unlimited" purchases of government debt that will then be "sterilised" to calm market concerns about printing money.

Earlier this week Draghi (above) said the ECB must intervene in bond markets to wrest back control of fragmented eurozone interest rates. But the programme, dubbed "monetary outright transactions" in internal ECB discussion papers, may not be as open-ended as it seems.

There are conditions. To receive ECB aid, borrowers will be obliged to erase their budget deficits. Says Bloomberg: "The benefit of ECB bond-buying will be at least partially offset by the harm from contractionary fiscal policy."

According to two unnamed central bank officials, Draghi favours buying sovereign debt to push down interest rates and lower nations' borrowing costs. But he's against setting a limits on how much the ECB can buy to dissuade speculators from betting against the currency.

Draghi's intervention could hardly be more prescient. In July, euro-area finance ministers gave Spain an extra year, until 2014, to get its budget deficit below three per cent of gross domestic product. But Bloomberg Businessweek says Spain's economic crisis has passed another milestone, as new central bank data shows that capital flight from the country now far exceeds levels reached in Asia during that region's financial crisis in the 1990s.

Draghi's initiative goes against the wishes of Germany's Bundesbank. But the bank doesn't have the votes in the ECB's governing council to prevent a plan it says is tantamount to financing a nation's budget deficit. In a concession, ECB creditors will demand to see deficit-cutting action before they extend more credit.

"Is that going to put the economies in a bigger hole in the short term? Yes. There's no question about that," says Duke University economist Juan Rubio-Ramirez. "But first things first. Without solving fiscal problems, nobody¹s going to buy that debt, so it¹s impossible to grow."

Says the Financial Times, Italy and Spain's benchmark borrowing costs fell on reports of Draghi's plans, while the euro reversed its early losses to end the day markedly higher against the US dollar.

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