It’s D-Day for the euro-zone. The time has come to deliver (or disappoint on the strong words released one week ago. Is Draghi up for saving the euro?
There’s no doubt that the ECB has the tools. Here are all the current options on the table, with explanations if they consist of a delivery or a disappointment. Draghi’s decisions and words will impact all currencies and stock markets, not only the euro.
Summary: Draghi Didn’t Deliver – Overestimated Spain and Underestimated Germany
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Update: the ECB left rates unchanged. One option less.
- Full QE: An announcement about buying Spanish and Italian bonds en masse in the markets, without draining out the money. This is the “nuclear†option and has many advantages in containing the crisis. For this to work, the ECB would have to buy big amounts of bonds and announce that it doesn’t have seniority over private bondholders. Delivery.
- Soft Bailout for Spain: According to some reports, Spain will officially ask for help, announce new cuts and will be rewarded with ECB bond buys. This would be a soft bailout, bypassing the ESM and German constitutional court. This option would be positively received. Delivery.
- ESM Banking License: Allowing the ESM bailout fund to borrow from the ECB, and perhaps even use leverage, is another significant step forward, but it requires a treaty change. The current ESM is still awaiting approval in Karlsruhe. Mixed. The reaction would be cheered at first but the complication would hurt it.
- ESM + ECB Bond Purchases:Â Another option being discussed is that the ECB will buy bonds in the secondary market and the ESM will do it in the primary market (at bond auctions). Similar to the banking license option, this depends on the implementation.Mixed.
- LTRO 3: The previous loans to banks eventually backfired. Trying this once again will likely end in another failure to tackle the burning issue of high borrowing costs. Disappointment.
- Rate cuts: After breaking the 1% barrier on the lending rate and wiping out the deposit rate, Draghi could make another cut on the main rate and introduce a negative deposit rate. This falls short of tackling the yields. Disappointment.
- Looser Collateral Rules: The ECB can lower the grade of collateral it accepts for loans, thus ignoring rating agencies and preparing for more downgrades. Draghi did this in the past. This step alone, is not enough. Disappointment.
- The Greek option: Greece will run out of money on August 20th if it doesn’t get money from the troika. On August 20th, it has a bond repayment to the ECB. Draghi could announce a delay in the payment, thus helping Greece. This step alone would not be enough. Disappointment.
Draghi could announce more than one step. Going for any mix of steps 5-8 would not be sufficient. Only acting directly to lowering the yields of Spain and Italy would be sufficient.
Immediate action in the bond markets would have a much stronger effect than a proposed plan that awaits treaty changes and / or the approval of the German court.
The ECB has the all the tools to turn a corner in the debt crisis, but there are many reasons why Draghi could disappoint. Most of them come from Germany.
