The oscillations of the European debt crises have become quite familiar to those observing it. A country or national bank suffers from a negative spiral of debt and fading confidence. This is followed by a new nudge in the direction of deeper integration, or a bailout package is announced. A northern country which is fiscally sound then makes a controversial statement of refusing to cooperate on the terms proposed. This process muddles on until a new country or institution is in a dire situation. Like last year, summer holiday season generates the greatest divide between the political process and the factors that affect the crisis.
Quite apart from this has been the European Central Bank. For this reason, Mario Draghi, its president, recently caused a stir that reverberated far from the usual central bank watchers.
In a speech at an investment conference in London, Draghi went against two developments. First, central banks have historically been excruciatingly vague in their announcements regarding future action. Draghi’s speech was quite blunt. Second, the announcement can be interpreted as a commitment by the central bank to safeguard government bond yields from rising too high. This could in effect generate the expectation of future interventions in the bond markets, which may permanently lower yields. Of particular interest are the following passages.
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Then there’s another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia have to do, as I said, with default, with liquidity but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty — they come into our mandate. They come within our remit.
The last paragraph especially seems to indicate that the European Central Bank will intervene when it expects yield increases to have little do with governments’ solvency rather other factors affecting the borrowing costs of eurozone states. Whether this is the central bank backing that many have been hoping to see remains unknown. Future interventions will not only indicate the extent of support but also show through what institutional setup it will come through.
Markets were quick to react nevertheless. Bond yields for both Italy and Spain have come down somewhat, despite news of rising unemployment in Spain and further complications in Greece. This is perhaps becoming the familiar role played by the bank: like the tremendous liquidity provision during 2012 December holidays, it may have once again taken a step toward saving the single currency.