ECB’s New Bond Plan: OMT! Crisis Averted, for Now

The European Central Bank’s new bond buying program buys time for the embattled euro zone but leaves the ball in the court of Madrid and Rome, telling them that purchases of sovereign bonds would come with strict conditions.

European Central Bank
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European Central Bank

The ECB effectively said it was standing by to buy unlimited quantities of short-dated Spanish and Italian bonds in the secondary market if Madrid or Rome request such a move. The new program, known as Outright Monetary Transactions or OMT, will be conditional on an EFSF/ESM program (learn more), the programs that countries must implement in return for financial aid.

The plan will “assist the monetary policy transmission mechanism in all euro area countries,” Draghi told a news conference Thursday, referring to the process through which monetary policy decisions affect the economy.

“All in all, the ECB has presented a big new bazooka which should help buying time. This is probably the furthest the ECB can go to help governments,” Carsten Brzeski, senior economist at ING, said in a note to clients.

Nicholas Spiro, managing director at Spiro Sovereign Strategy, said Draghi had placed the bond-buying ball firmly in the court of Madrid.

Brzeski said the emphasis on the transmission mechanism was a danger and contained a contradiction.

“With the OMT, the ECB will only repair the transmission mechanism in countries with ask-for EFSF/ESM. But what about the other countries? It remains a bit strange,” he said.

Short-term Italian and Spanish yields fell following the announcement and the euro rallied.

“We didn’t quite get the full Monti today, but I think we got about three quarters of it and that’s what you see in the markets. For now, I guess it’s good enough and that’s what the euro/dollar shows,” Boris Schlossberg from BK Asset Management told CNBC.

Pimco's Bill Gross tweeted that the ECB plan will help stabilize front-end yields, but added that euro zone healing depends on growth, which remains and should continue negative.

Figures released earlier Thursday confirmed that the euro zone economy contracted by 0.2 percent in the second quarter. Many economists do not expect a recovery before mid-2013.

“It’s meant to buy time for fiscal adjustment, and to make progress on that banking union,” said Barry Knapp, head of U.S. equity portfolio strategy at Barclays.

“The fiscal adjustment is going to prove difficult. We probably won’t get the stabilization in the economy. Banking union could provide difficulties as well. There’s a two-month window," he said. "Towards the end of the year, we could be back in the midst of a severe crisis.”