At last, the ECB announces unlimited intervention!

Mario Draghi has finally delivered what was very close to investors’ expectations. In announcing the Outright Monetary Transactions (OMTs), the ECB will put up its almost unlimited balance sheet to serve as a backstop in this crisis. The main key word in yesterday’s announcement was “unlimited”.

The key points of the ECB’s announcement are the following:

Unlimited: No ex-ante quantitative limits are set on the size of OMTs. Conditionality: The necessary condition for OMTs to be triggered for a member state is to be under an EFSF/ESM programme.
Targets: As expected no explicit interest rate or spread targets were announced. Nevertheless, the ECB is expected to work within an implicit band of intervention.
Term: The ECB’s Governing Council will consider OMTs as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance.
Decision: The Governing Council will decide on the start, continuation and suspension of OMTs at its entire discretion. Members support: The decision to undertake OMTs was unanimous minus one voice: the Bundesbank is against such a programme.
Coverage: OMTs could also be considered for member states currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Yield curve: Interventions will be focused on the shorter part of the yield curve, in particular on sovereign bonds with a maturity of between one and three years.
Seniority: The ECB accepts the same treatment (pari passu) as other creditors.
Sterilisation: The ECB plans to fully sterilise the liquidity created through OMT.
Transparency: OMT holdings will be published on a weekly basis. The average duration and the breakdown by country will be published on a monthly basis.
SMP: The decision to announce the OMTs has, as a direct consequence, put an end to the previous bond buying programme, the so called Securities Markets Programme.

The euro area can finally rely on a fully operative central bank
The fact that no explicit cap on the interventions has been announced should give sufficient credibility to remove convertibility risk premium and deter speculating on the euro’s break-up. The euro area can finally rely on the full cooperation of its central bank. As such, the ECB is now more comparable to the Fed or the Bank of England in this crisis. But transparency combined with the Bundesbank’s dissension risk testing the limits of the OMT if the ECB’s balance sheet balloons out of control and shows that in practice the programme is not as unlimited as initially announced.

Interventions beyond 3-year sovereign not excluded
As mentioned in the press release, the OMTs will focus in particular on sovereign bonds between one and three years but intervention beyond this range and on private debt are not explicitly excluded.

Rate cut postponed
On top of the OMT announcement, we were expecting a 25bp rate cut in the refi rate, but this was clearly too much to digest for the same session. When asked about it, Mario Draghi clearly hinted that a further rate cut remains on the cards and could come rather soon. We thus maintain our forecast of a refi rate at 0.5% before year end. The move could occur as early as next month’s meeting.

GDP forecasts down, inflation up
As expected, the real GDP growth projections have been revised down. The middle point is -0.4% for 2012 and +0.5% for 2013, more in line with our forecasts. Inflation was revised in the opposite direction: the middle point is now at 2.5% for 2012 and 1.9% for 2013. We continue to expect inflation in the lower range for 2013.

What next?
We expect the Spanish government will ask for aid soon in order to trigger OMTs on its debt. The situation is politically more complicated in Italy. Mario Monti will probably try to avoid a formal request and surf on the benefits that it will reap from the OMTs on Spanish debt. Greece remains a clear concern. Fiscal results are certainly out of target. A third EU bailout is very unlikely. The IMF could be impeached (by internal rules) to pay its tranche if Greece’s medium-term financing is not guaranteed. Hence a Grexit remains likely and, in any case, will continue to generate noise in the market.

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