The ECB announces details behind its new bond purchase programme

 

known as Outright Monetary Transactions (OMT), the sovereign bond purchases will be targeted on the shorter end of the curve, with maturities of one to three years…

 

…purchases will be fully sterilised, are unlimited, with no specific yield target and the ECB will not have seniority…

 

… governments must be prepared to sign up to an appropriate EFSF/ESM programme as a necessary condition for the OMT…

 

…decision on the OMT was not unanimous, with one dissenter…

 

…some easing of collateral arrangements…

 

…the Governing Council did discuss interest rates, but felt now was not the right time to alter rates…

 

…However, updated staff forecasts show downward revisions to growth outlook, so expectation of further economic weakness leaves the door open for policy easing

 

As expected, today’s meeting of the Governing Council saw details announced in relation to a new bond purchase programme, called Outright Monetary Transactions. On the issue of conditionality for access to the OMT, a country will have to sign up to an appropriate EFSF/ESM programme before the ECB will start purchasing debt in that sovereign. These programmes can take the form of a full macro adjustment programme or a precautionary programme. The fact that a country can meet the conditionality clause by entering a precautionary programme is designed to enable a country such as Italy who might not want to enter a full programme, access to the OMT initiative. The involvement of the IMF shall be sought for the design of country specific conditionality and for the ongoing monitoring of the country against the specific programme targets.

 

In terms of the underlying details of the OMT, these were very much in line with what had been speculated and reported on over the last few days. The programme will involve the ECB buying sovereign debt at the shorter end of the yield curve, in maturities of one to three years. There is no limit on what amount the ECB will purchase, although in reality the size of the markets will act as a constraint to the amount of purchases. The purchases will be fully sterilised, meaning that the overall impact on the money supply will be neutral. There will be no specific yield target, however, in the press conference, President Draghi discussed a number of metrics, including level of yields, yield spreads, credit default swaps, and conditions of liquidity as indicators that the ECB will take into consideration when operating the OMT. One positive surprise, which had not been anticipated was in relation to the issue of seniority of the new bond purchase programme, with Draghi announcing that the ECB will not have seniority on bonds purchased under the OMT. On the matter of exit triggers for the OMT, the ECB will stop purchasing bonds in a particular sovereign if the objective of the OMT is complete or if the specific government fails to comply with the programme conditions.

 

Compared to their previous bond purchase programme (SMP), there are a number of key differences. There is conditionality attached to OMT which was not present in the SMP. The ECB does not have seniority on the bonds it will purchase under the OMT and the new programme has greater transparency, with OMT holdings and their market values published on a weekly basis, and details on average durations of the OMT and country breakdown available on a monthly basis.

 

Overall, today’s new bond buying plan is a positive development, with President Draghi delivering on what he had earmarked at the August press conference. In the context of the debt crisis, the new initiative from the ECB today helps to buy time for the sovereigns to implement measures to correct their fiscal imbalances and implement structural reforms. However, the OMT itself could be a source of volatility, given that a country will have to consistently meet the targets set out by the programme in order for the ECB to continue the OMT for that country. From an Irish perspective, the OMT initiative would be available to Ireland once it has finished its macro adjustment programme and is regaining market access. On balance then, the OMT is a progressive move from the ECB and marks a new phase of the ECB’s policy approach to the helping resolve the market tensions linked to the debt crisis. It is now in the hands of the political leaders in Europe to build on this new bond buying initiative from the ECB.

 

On the more mundane matter of traditional monetary policy (i.e. changes to interest rates), it is clear from the statement (one of three today) that the Governing Council maintains an easing bias given their ongoing awareness of the downside risks to the economic outlook and the potential for these risks to materialise. The updated staff forecasts reflect a weaker economic outlook, with the 2012 GDP forecast revised down from -0.1 to -0.4 and the 2013 forecast revised from + 1% to +0.5%. We know that a rate change was discussed, however, the view amongst the Governing Council was that now was not the right time for a rate cut. Based on our view that there will be further deterioration in the economic outlook, we believe the Governing Council will ease policy further over the coming months in response to the weakening economic data. Ulster Bank