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Draghi Disappoints as Firepower Becomes Fig Leaf: Euro Credit

June 07, 2013

Draghi Disappoints as Firepower Becomes Fig Leaf

Mario Draghi, president of the European Central Bank (ECB), arrives for a news conference at the bank's headquarters in Frankfurt on June 6, 2013. Photographer: Ralph Orlowski/Bloomberg

European Central Bank President Mario Draghi isn’t racing to the rescue of Europe’s banks or economy this time.

Almost a year since his promise to do “whatever it takes” to protect the euro soothed investors, and a month since cutting interest rates, Draghi signalled yesterday that governments, not the ECB, should do more to fight recession and boost credit to businesses in cash-strapped countries such as Spain.

As he predicted a resumption of growth by the end of the year, Draghi’s maintenance of the status quo sent bonds falling and the euro rising as investors questioned the ECB’s crisis-fighting resolve, which previously reinforced its president’s “Super Mario” nickname. Yields on Spanish and Italian 10-year bonds jumped yesterday to the most in six weeks, while German two-year borrowing costs climbed to the highest since February. Markets rebounded today with rates falling across the region.

“Investors see ECB talk for what it is, a fig leaf,” said Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in Paris. “Draghi mentioned many possible measures, only to conclude that they are too hard to introduce.”

If the economy improves in the second half of the year, the ECB may refrain from further action as “the easy instruments have all been used,” Austrian central bank governor Ewald Nowotny said today.

Recession Risks

Draghi said the central bank currently sees no reason for “immediate action” after listing potential measures, including charging banks for leaving money on deposit with it and lending institutions cash over the long term.

A consensus of the ECB’s 23-member Governing Council yesterday left its key rate at a record low of 0.5 percent even as data this week confirmed the longest recession since the euro began trading in 1999. The bank cut its forecasts for this year to show the economy contracting 0.6 percent and inflation accelerating by 1.4 percent.

The Bundesbank today cut its growth outlook for 2013, after a disappointing first quarter. Europe’s largest economy will likely expand by 0.3 percent this year, down from a forecast in December of 0.4 percent, the Frankfurt-based central bank said.

That backdrop is enough to keep the ECB on the sidelines, said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “Financial markets interpreted Draghi as being relatively hawkish,” Kounis said. “Still, the ECB clearly has an easing bias in place.”

Collateral Framework

Having previously fanned speculation that the ECB would help revive the asset-backed securities market and tweak its collateral framework to ease banks’ access to cash, Draghi said yesterday that wasn’t a plan for the short term. He instead left the onus on governments to act to recapitalize lenders before any central bank aid would be offered.

When an ECB-led round of asset reviews and stress tests are completed next year, governments need to make “an explicit commitment” to provide a backstop in the event of a “capital shortfall,” he said.

While Europe’s largest banks have been rebuilding their capital buffers, profitability remains weak and lenders are still vulnerable to economic downturns, the ECB’s Financial Stability Report said last week. Median core Tier 1 capital reached 11.1 percent in the first quarter of this year, up from 9.6 percent at the end of 2011, the ECB said.

The ratio of bank loans not being paid back will probably increase until mid-2014 because of the recession, Giovanni Sabatini, head of Italy’s banking association, said on May 31. Lending to euro-area private-sector companies and households has fallen in annual terms every month for the past year.

Bond Buying

To Marc Ostwald, a strategist at Monument Securities Ltd. in London, the lack of fresh stimulus reflected Draghi’s inability to rally colleagues as he once did amid concern the ECB’s previous largesse has led politicians not to take their own measures.

Draghi, who took office in November 2011, reprised his “Super Mario” moniker in financial markets with his as-yet-untapped Outright Monetary Transactions program, a pledge to buy government bonds to cap yields. He has also trimmed interest rates by a cumulative 1 percentage point since taking office, and extended cheap loans to banks.

Ahead of a review by Germany’s constitutional court, Draghi called the bond-buying OMT the “most successful monetary policy measure” of recent times and said the ECB was prepared to use it if a country sought it and satisfied its economic-reform requirements. He also said the bank is technically ready for negative interest rates, while noting the move risks unintended consequences.

Opinions Differ

The OMT remains unpopular with Bundesbank President Jens Weidmann, while Nowotny is among those who have distanced themselves from negative deposit rates.

“Draghi’s activism is no longer supported by many members of the council,” Ostwald said. “His attempts to jawbone financial markets into a sense of security highlight the lack of support from his fellow ECB council members.”

Draghi rejected speculation of splits within the council as a “dramatization,” and said differences were common among policy makers. He praised the ECB’s “conservatism” at a time when the Federal Reserve is considering slowing bond buying and the Bank of Japan is ramping up its quantitative easing.

“The ECB is clearly trying to manage down expectations of it playing a leading role in dealing with financial fragmentation,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London. “The parlous state of the peripheral banks cannot be solved by the ECB, and it can only play a peripheral role in solving the structural financial fragmentation problem.”

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net


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