ECB Credibility Fears Raised by Stark Resignation
It has been another dramatic weekend in the euro zone. On Friday, Germany’s representative on the European Central Bank's governing council, Juergen Stark, resigned in protest at the bank's decision to buy Italian and Spanish bonds. He will be replaced by German deputy finance minister Joerg Asmussen.
Then we had a report from Germany indicating that the government in Berlin is now studying the possible effect of a Greek default, or the possibility of Greece actually leaving the euro , as the German economy minister said a Greek default is no longer a "taboo." On the positive side, Greece introduced a new property tax that the government in Athens hopes will raise 2 billion euros a year and help it gain access to the next tranche of aid from the European Union and/or the International Monetary Fund .
Analysts believe Stark’s resignation will not affect the bond-buying program, but will add to the unpopularity of governmental policy in Germany.
“The clear majority in favor of bond purchases within the ECB council means that the ECB will continue to buy huge amounts of peripheral government bonds in the coming weeks,” said Joerg Kraemer, the chief economist at Commerzbank, in a research report.
“Our main scenario remains that the politicians will continue the bailout policy to prevent an open escalation of the sovereign debt crisis. Thereby, they contain risks for the global economy although such a bailout policy creates incentives to run budget deficits at the expense of the other countries,” said Kraemer, who believes German public opinion will now harden toward the ECB’s policy. “The second resignation of a German ECB board member makes this policy more unpopular among German voters."
For Julian Callow at Barclays Capital, the news came as a major surprise, but he too sees little impact on ECB policy.
“Mr. Stark's resignation will not have a major effect on the Governing Council's decisions. Even though he has been an influential member of the Council, we should note that the Council operates on a consensus principle, with all 23 members being required to consider their decisions on the basis of the ECB's mandate, which is to maintain price stability across the euro area,” Callow said on Sunday.
The resignation does, however, add to the uncertainty at the ECB about where Jean-Claude Trichet will be replaced by Maria Draghi as president later this year.
“On the one hand, it could be seen that such turnover will give significant opportunity for Mr. Draghi to exercise influence in terms of defining the ECB's monetary policy,” said Callow, who like Kraemer is worried about the effect on German public opinion.
“Mr. Stark's departure could be seen by financial markets as another indication of growing disenchantment in Germany towards the euro. Mr. Stark's successor, together with the Bundesbank, will have a vital role in ensuring that the ECB's policies are well understood and accepted in Germany,” he said.
Goldman Sachs believes the ECB’s credibility is its most valuable asset and that the central bank could be forced to risk its credibility at some point to avoid a “serious financial crisis.”
With the ECB’s balance sheet standing at 2 trillion euros, Dirk Schumacher, a senior European economist at Goldman Sachs, believes the central bank has more room to expand further but warns that the risk is that the market begins to question its credibility.
“Credibility, the belief of the general public that a central bank is willing and able to fulfill its mandate, is a necessary prerequisite for a successful implementation of monetary policy,” said Schumacher in a research note on Monday. “It is easy to see that the trust of the general public would suffer if a central bank were considered not to be in a position to protect its own balance sheet.”
As a result, Schumacher believes the ECB will be constrained by the potential for the market to question its financial health even if technically it has a lot of room for maneuver.
“This is not to say that this would be binding to the extent that the ECB would rather risk a systemic event than have to show a weak balance sheet. But it nonetheless reduces the ECB’s flexibility in using its balance sheet,” said Schumacher.
The ECB could always print money, according to Schumacher, who warns that inflation could then be a major problem.
“If the ECB’s financial strength were to suffer to such an extent that a recapitalization were needed, it could ‘print the money’ to recapitalize. This may in fact be the only option if these losses came from defaulting sovereign bonds, implying that governments would not be in a position to recapitalize the ECB,” Schumacher said.