Yesterday, when Bloomberg leaked every single detail of today’s ECB announcement, which thus means today’s conference was not a surprise at all, yet the market sure would like to make itself believe it was, we noted that everything that was leaked, and today confirmed, came from a Goldman memorandum issued hours before. Simply said everything that happens at the ECB gets its marching orders somewhere within the tentacular empire headquartered at 200 West. Which is why when it comes to the definitive summary of what “happened” today, we go to the firm that pre-ordained today’s events weeks ago. Goldman Sachs.Perhaps the most important part is this: “September 13-14: Spain to make formal request for EFSF support at the Eurogroup meeting. With a large (and uncovered) redemption looming at the end of October (and under pressure from other Euro area governments), we expect Spain to move towards seeking support.” In other words, Rajoy has one more week before he is sacked and the Spanish festivities begin.
From Goldman’s Dirk Schumacher
ECB meeting: Introducing the OMT
The announcements made at today’s ECB press conference were broadly in line with our expectations. An overwhelming majority of the Governing Council agreed to “address severe distortions in government bond markets, which originate from, in particular, unfounded fears on the part of investors of the reversibility of the Euro”. We view the ECB’s determination to provide a “fully effective backstop” as credible and, while we will only learn over time the practicalities of implementation (such as the range of yields the ECB deems consistent with an ‘irreversible Euro’ and thus will tolerate), today’s decision has nonetheless reduced tail risks in peripheral countries, at least in the shorter term. This should buy peripheral economies time to implement the consolidation and reforms needed to provide fundamentals consistent with continued Euro participation.
Details of the OMT
In order to qualify for the new Outright Monetary Transactions (OMT) program, countries will need to be participating in either a full or precautionary EFSF/ESM programme and accept the implied conditionality. IMF involvement will be sought in this context and the IMF has meanwhile released a press statement “strongly welcoming” the ECB’s decision, saying that it would cooperate with the ECB “within our framework”. Failure to fulfil the conditions established in the programme would lead the ECB to cease purchases. Existing programme countries can also qualify for the OMT “if they have regained bond market access”. What this means in practice (i.e., will it be necessary to issue a certain volume in order to prove that there is market access?) remains to be seen.
Purchases will concentrate on bonds with a maturity from one to three years, and will be fully sterilised. The ECB is already sterilising the purchases made under the SMP through weekly reverse tenders. These tenders drain the amount of money from the banking system that the ECB spent on buying peripheral bonds. The specifics of how OMT purchases will be sterilised have not been announced, but our base case is that they would take place in the same manner. The ECB will demonstrate greater transparency in publishing the magnitude, duration and country composition of the debt holdings accumulated under the OMT.
In the legal documentation establishing the OMT, the ECB will explicitly renounce any claim to seniority of its sovereign debt holdings under the programme. The Securities Markets Programme (SMP) will now be terminated, with the ECB retaining its senior creditor status for bonds purchased under the SMP.
Activating the OMT
With the ECB now having outlined its sovereign bond purchasing framework at least in skeletal form, the ball is now in the governments’ court. Front and centre lies Spain.
Looking forward, we expect the following time-line in our base case:
- September 12: German constitutional court gives its blessing to the ESM. Although we expect some procedural riders to be attached to the decision, this would allow German ratification to be completed and the ESM to be established in relatively short order.
- September 13-14: Spain to make formal request for EFSF support at the Eurogroup meeting. With a large (and uncovered) redemption looming at the end of October (and under pressure from other Euro area governments), we expect Spain to move towards seeking support.
- Second half of September: Conditionality required by EFSF will have to be accepted by the Spanish authorities, presumably requiring a parliamentary vote. In parallel, approval of other Euro area countries for the provision of EFSF support will need to be obtained: in some countries (notably Germany), this will also require parliamentary approval.
- By end-September / early October: Memorandum of Understanding (MoU) codifying conditionality is signed, formalising the availability of EFSF support for Spain. At this point, the necessary conditions established by Mr. Draghi for ECB purchases of sovereign debt will have been met, well ahead of the large Spanish bond redemption.
At that point, the ECB would stand ready to purchase short-dated Spanish government securities should rates back up. Market conditions at that stage will dictate whether such interventions take place. Risks to this base case are largely political: a Spanish reluctance to seek EFSF support given the current lower level of yields; or German parliamentarians deeming the agreed conditionality too light. Even if these political risks materialise, we would still expect Spain to be forced to seek EFSF support in the course of October as market conditions deteriorate as a result of the delay.
No rate cut – renewed deterioration needed for further easing
Returning to the ECB’s announcements this afternoon, as far as standard policy measures are concerned, policy rates were left unchanged as the Governing Council saw no need to change its economic or inflation outlook on the back of the latest data. The ECB staff growth forecasts were revised down significantly, moving substantially closer to our own macroeconomic projections for 2012 and 2013. A renewed deterioration of the Euro area economy, however, could well shift the majority in the Governing Council towards a further easing. In any case, we think the Governing Council views it as more pressing to ensure that low policy rates are actually passed on to the real economy in those countries where this is needed most. Unclogging the monetary policy transmission mechanism, by means of its non-standard measures, therefore remains the main priority of the Governing Council.
Changes to the collateral framework, but nothing more on non-standard measures for now
The ECB also widened collateral eligibility to foreign currency denominated bonds and, for countries benefiting from EFSF/ESM support, suspended the minimum credit rating threshold on sovereign debt. There had been, according to President Draghi, no discussion of another LTRO. We saw the possibility that the Governing Council would reduce haircuts for some assets that are being posted by banks as collateral (and the elimination of the ‘cliff’ risk associated with sovereign downgrades in programme countries should have such an effect) but, at least for the time being, the focus is on the OMT. That said, remarks made by President Draghi during the Q&A part of the press conference suggest that the ECB may contemplate other non-standard measures if credit conditions in peripheral countries do not improve. Such measures could include the outright purchase of private bank debt and/or corporate debt.