Is the ECB’s Bond Plan a Game-Changer for the Euro?
The European Central Bank’s (ECB) much awaited announcement on Thursday that it would buy sovereign bonds in a new program to ease the euro zone debt crisis could help the battered euro reclaim its clout as a major global currency, say analysts.
The euro rose to a two-month high against the dollar after the ECB unveiled new and possibly unlimited steps to buy the bonds of those euro zone countries that have faced painfully high borrowing coststhis year. It extended its gains on Friday, rising above $1.28.
The ECB President Mario Draghi said the central bank would buy bonds with maturities of up to three years once those euro zone countries in need of help agreed to strict conditions to improve the state of their finances.
“What Draghi is doing is changing the dynamics of the euro zone and turning the euro into a real currency. Meaning, he tells the government (needing help) if you submit yourself to a central fiscal authority, we will act like a proper central bank and buy your short-term debt,” Axel Merk, President and Chief Investment Officer at Merk Investments, told CNBC Asia’s “Squawk Box” on Friday.
He added that the ECB’s decision showed that policymakers are committed to control the debt crisis, putting the euro on a more sustainable path in the long-term.
“Now, I’m not going to pretend that everything is going to be great in the euro zone, but it (the ECB’s measures) does take off the so-called ‘tail risks,’ it makes the euro less risky,” said Merk adding that the new framework of the ECB morphs the euro from a currency of nations to a currency of the United States of Europe.
The euro has ended the past two years lower against the greenback – battered by weak economic growth in the single currency zone along with its debt problems. In July, when fears about the future of Spain’s economy grew as government bond yields soared above 7 percent, a level widely seen as unsustainable, the euro plunged to two-year lows against the dollar.
And despite gains in recent weeks in anticipation of ECB action, the single currency continues to lag other major global currencies.
The euro is down about 2.4 percent so far this year, underperforming Europe’s other big currencies - the Swiss franc is up almost 2 percent, while the British pound has gained around 2.5 percent.
Still, if investors were really worried about the outlook for the euro zone, the single currency would be much lower, says Andrew Ferris, Chief Investment Advisor for Asia at BNP Paribas Wealth Management.
“For me the best argument about why the euro is not going to collapse is to look at what the markets are telling you and what the markets are telling you is $1.26, $1.22 – that’s not a euro worth nothing,” Ferris told CNBC. “If the euro area was going to be dissolvedthe euro would not be at these levels.”
For Merk, the improved outlook for the euro comes from the fact that the currency becomes a less risky asset to hold in the wake of the ECB’s bond-buying plan.
“In the short-term, it (the bond-buying plan) does make the euro less risky, all the other currencies are pricey, that’s why in recent weeks money has been flowing into the euro. Going forward, we will have to see how the dynamics will play out, but for now Draghi has achieved what nobody else has achieved. He is imposing a process on how to move forward,” Merk said.
“We think the euro is going to do well in the years to come… It is becoming a different currency with different dynamics in place,” he added.
—By CNBC’s Dhara Ranasinghe