The European Central Bank (ECB) has dragged the eurozone back from the edge of the abyss, says Economist.com. By the end of last week, the yields (the total annual return demanded by investors) on Spanish and Italian bonds were threatening to spiral out of control and shut the two countries out of debt markets, raising the spectre of default. So the ECB waded in, buying up an undisclosed amount of Spanish and Italian debt to bring yields back to sustainable levels (yields fall as prices rise). On Monday, ten-year yields in both countries slid by a whole percentage point to just over 5%.
What next?
But this is only a short-term fix. Note, says Ambrose Evans-Pritchard in The Daily Telegraph, that “the ECB failed to stop Greek, Irish and Portuguese yields from spiralling out of control before each needed a rescue”, even though it bought a fifth of their combined debts. This episode seems unlikely to break the pattern.
One problem is that the ECB is “a reluctant rescuer”, says Economist.com. This bond-buying programme came after immense pressure from political leaders. The main issue is its independence. It has always felt that buying up bonds “drags it” into fiscal and political territory: it is spending taxpayers’ money as its balance sheet is backed by funds from eurozone members. Nor is its board unanimous, with German members dissenting, according to David Marsh of think-tank the Official Monetary and Financial Institutions Forum. The statement accompanying the purchases showed that the ECB “is clearly not going in with all guns blazing”, he says.
The ECB is “desperate to hand over the baton” to the eurozone’s rescue fund, the European Financial Stability Facility (EFSF), notes Nils Pratley in The Guardian. In a July summit, EU leaders agreed to expand its remit to include bond purchases. But that decision has to be ratified in the eurozone’s national parliaments – and this could be as late as October. But how much firepower will it get? “Germany seems dead-set against an increase from the current €440bn, which won’t do much if markets again start to doubt Italy and Spain’s creditworthiness.”
Europe lacks firepower
The EFSF certainly can’t cover a bailout of Italy, Europe’s third-biggest economy, says Peter Thal Larsen on Breakingviews. Besides, beefing it up would greatly increase the burden on its two biggest members, France and Germany – the fund is backed by state guarantees, which allow it to raise money in the market. With French yields already creeping up, France could lose its AAA credit rating if the EFSF is expanded. That would force Germany to bear more of the burden.
The bottom line, says Brian Blackstone in The Wall Street Journal, is nobody knows for certain how much bond-buying the eurozone would have to do to allay fears of Spain or Italy failing to get their debt under control. But the sum seems likely to be higher than Europe can muster. According to Jacques Cailloux of RBS, Europe will have to buy up almost half the long-term debt of Italy and Spain, or about €850bn, to stem selling pressure. “This huge risk-pooling will not come easily and the risk of political fallout will be large.”
It’s up to Germany
Meanwhile, the basic problem remains. Both Spain and Italy are in danger of eventual default, says Capital Economics. The latest lacklustre growth figures cast doubt on whether they can meet this year’s budget deficit goals. The new Italian plan to return the budget to balance by 2013 rests on overly optimistic growth forecasts. So the key issue is still whether Germany is prepared to prevent a potentially catastrophic break-up of the eurozone by committing yet more taxpayers’ money and endorsing moves towards fiscal union. With German government figures in “near revolt”, says Evans-Pritchard, that’s hardly a done deal.