ECB Holds Back From Bond Yield Cap

The European Central Bank will refrain from publishing any formal cap on bond yields when it announces a new plan to buy distressed eurozone sovereign debt at its governing council meeting on Thursday, two people familiar with the matter said.

Part of the giant euro sign outside the Eurotower, home of the European Central Bank, in Willy-Brand-Platz, Innenstadt district.
David C. Tomlinson | Lonely Planet Images | Getty Images
Part of the giant euro sign outside the Eurotower, home of the European Central Bank, in Willy-Brand-Platz, Innenstadt district.

The program, dubbed “monetary outright transactions” in internal ECB discussion papers, was first outlined last month by Mario Draghi, the bank’s president, and – after fierce debate over its merits – is set to be revealed in detail following the meeting of the bank’s executive board and the 17 heads of eurozone central banks.

It has met with open oppositionfrom the German Bundesbank, the guardian of the doctrine that central banks should focus solely on price stability. The leaders of France, Spain and Italy have by contrast lobbied hard in favor and they were joined on Wednesday by leading business groups from those three countries and Germany, who called for “decisive actions” from European institutions including the ECB and governments.

Investors too have welcomed the prospect of intervention.

“We haven’t had a single monetary system for a few months now,” said Ewen Cameron Watt, a senior fund manager at BlackRock, the world’s biggest asset manager. “Money is leaking out of these periphery countries and causing a dysfunctional monetary system, which is not something a central bank can allow.”

Yet, underscoring concern about the plan’s risks, the central banks of the Netherlands, Belgium, Luxembourg and Finland have put discussing a credible exit strategy on the agenda for Thursday morning’s meeting before Mr. Draghi speaks in the early afternoon, according to one person familiar with the matter.

Mr. Draghi said from the outset that the programme – aimed principally at keeping the market interest rates of Spain and Italy from spiraling out of control – will come with strings attached in the form of structural reforms and budget controls.

The biggest single risk is that a country enjoying the benefits of the bond-buying regime will renege on its commitments, leaving the ECB with the choice of pulling the plug on the programme – potentially triggering market panic and a default – or continuing its purchases.

It is unclear how Mr. Draghi will tackle this issue. As well as not publishing any bond yield cap above which it will intervene, one person familiar with the situation said the bank would also refrain from doing so inside the bank, after its experts tried and failed to come up with models for deciding what the “fair value” of a Spanish or Italian bond would be.

As expected, the programme will focus on buying debt in the secondary market with a maturity of up to about three years and the purchases will be “sterilized” to maintain a neutral effect on money supply, the person said.

The ECB had no comment. A third person familiar with the situation stressed final decisions about the plan would be agreed on Thursday.

Mr. Draghi has insisted the plan does not stray into what for it would be the illicit world of “monetary financing” as it is seeking to fix a situation in which interest rate signals set in Frankfurt are no longer affecting rates in Spain and Italy because markets are effectively pricing in the risk that these countries will leave the euro. He has also signaled the bank may drop its preferred creditor status.

Italy and Spain’s benchmark borrowing costs fell after reports of Mr. Draghi’s intentions, while the euro reversed its early losses to end the day markedly higher against the US dollar.

Additional reporting by Peter Spiegel in Brussels and Hugh Carnegy in Paris