ECB Bankers Toil Over Bond-Buying Plan

When the world’s central bankers make their annual trip to Jackson Hole it often makes news. But seldom has a central banker’s non-attendance at the Federal Reserve Bank of Kansas City’s symposium grabbed so many headlines as ECB president Mario Draghi’s decision this week to pull out.

European Central Bank
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European Central Bank

Other members of the ECB’s executive board, made up of the central bank’s top six officials, have also cancelled their plans to travel to Wyoming.

The board’s decision to remain in Frankfurt indicates much remains to be done before next Thursday’s meeting of the governing council, immediately after which the bank is expected to unveil the details of its revamped bond-buying program.

“We don’t think it is too great a step into grassy knoll territory to conclude that a Draghi no-show at Jackson Hole likely reflects the fact that discussions within the senior echelons of the ECB are still going on over the design of the new program, and a final sign off is still some way off,” said Michael Michaelides and Richard Barwell, economists at RBS, in a note.

Jens Weidmann, the head of Germany’s Bundesbank who has been a vocal critic of central bank bond buying, will still attend Jackson Hole, although only for one day, rather than three as originally envisaged.

Within the ECB’s Eurotower headquarters, three committees of officials from each of the 17 national central banks that make up the euro zone have spent most of August debating the details of the new program. Last week, they presented summaries of their at times heated debates to the executive board. These displayed a vast range of views over how the program should work, according to two people familiar with the discussions, leaving the executive board with the tricky task of drawing up a draft plan for the program that takes into account those differences of opinion.

The board’s plan will be presented over the weekend or early next week to the heads of the national central banks that sit on the governing council before their policy meeting, which begins on Wednesday afternoon. The most likely scenario is that almost all those 23 central bankers will be able to agree on the plan by September 6. But there is an increasing degree of doubt as to whether a sufficiently strong consensus will form on some of the operational details.

Three areas of disagreement have emerged. The most controversial is over how the ECB can enforce the conditions placed by the EU on countries which have bonds the bank may purchase.

Mr Draghi has on several occasions said that further bond buying by the bank is conditional on governments signing up to commitments to reduce their budget deficits and implement structural reforms. But some members of the governing council are concerned that the ECB will be forced to continue its bond purchases even if a country missed targets set by the EU.

If purchases were stopped at the same time as a country missed targets, then yields could soar. This could force the ECB into a position where it has to act to avoid a financial meltdown.

Luc Coene, governor of the National Bank of Belgium, voiced his concern this month that governments could renege on commitments once the ECB began buying bonds. “The conclusion is clear: when you take away the market pressure, you take away the pressure to act.”

Views have also differed between the national central banks over whether, as part of the program, the ECB should announce an explicit cap on the spread between German bond yields and those of other governments. Mr Weidmann said over the weekend that he believed he was not the only member of the governing council to feel uncomfortable with the idea of an explicit cap.

“I suspect it would be more than just the Bundesbank that would object to explicit targets,” said Julian Callow, economist at Barclays. “If you are setting an additional objective to your main objective [of price stability], then there is a danger that policy might have to adjust to the second target.”

Steven Major, head of fixed income research at HSBC, warned against the ECB announcing explicit targets. “Too much transparency might set up a target to be hit and there is an argument for being more enigmatic.”

The third area of disagreement has been how the ECB will determine how much of the bond prices reflect the “convertibility risk” associated with a possible break-up of the euro zone, which Mr Draghi has vowed to counter.

It would be better for the ECB to use internal calculations of the convertibility risk to guide its intervention in bond markets, but to keep the public message simple, Mr Major said.

“President Draghi could just say that the aim is to remove any risk of the euro zone breaking up, without specifying what that meant exactly.”