ECB acts as expected, now the waiting game begins

For anyone following twitter yesterday around the ECB’s announcement and press conference it would seem as if we have just had another ‘whatever it takes’ moment (when ECB President Mario Draghi promised to backstop the eurozone).

However, stepping back for a moment and it becomes clear that the ECB acted more or less as expected and some would argue has done the minimum necessary to retain its credibility and not be labelled an ‘all talk’ institution.

Sure, the package of measures looks more impressive when strung together but as we discussed in detail here and here, few if any of them address the crux of the problems in the eurozone which are depressing inflation and growth (delayed impact of internal devaluation, rebalancing of various economies, recapitalisation of banks and the breakdown of the eurozone’s cross border financial system).

All that said, there were a few more subtle and interesting takeaways from Draghi’s press conference.

Unanimous support is impressive but unlikely to apply to further easing
Draghi stressed that the support for this entire package of measures was unanimous. This is quite surprising given the previous Bundesbank opposition and does add weight to the strength of the decision. That said, just because unanimity was agreed here does not mean it can be easily translated into support for much stronger action such as asset purchases. In fact, Draghi’s hesitancy to talk about such a programme in more depth and the ECB’s willingness to push ahead with one suggests a lack of consensus on the issue. Furthermore, the outcry in Germany has already begun and will likely make central bankers think twice about stronger easing action.

Draghi insists the ECB is not “finished”, but its mighty close
Over the past year, Draghi has waxed lyrical about all the tools at his disposal and we have analysed them all in detail – see here. However, with this package of measures he has come close to emptying his toolkit – he admitted as much on the rate side saying that, for all “practical purposes”, the lower bound has been reached.

True, he has pulled out many of the smaller tools and retains the big sledge hammer of asset purchases (Quantitative Easing through buying either private assets or government bonds) but the bar to take such action remains high and gaining support for it remains a huge challenge. Pushing the deposit rate further into negative territory is also unlikely to work as banks will simply begin hoarding hard cash – this of course has some cost in terms of storage and security but it will not be more than a fraction of a percent. Finally Draghi stressed that this package could take some time to have any impact, between three and four quarters (9 – 12 months), suggesting that the ECB is now in wait and see mode as the emphasis falls on governments and the bank stress tests to help push along the economic recovery.

Impact of long term lending operations relies on cross border lending being revived
As the useful chart to the left shows (from Morgan Stanley via FT Alphaville) the amount which banks can borrow is again limited in countries which need it (the periphery) due to their already underdeveloped markets in lending to small and medium sized businesses. The technical structure for the TLTRO (pronounced Tel-tro) does allow for them to borrow more if they lend more but this will take some time. Ultimately, the target seems to be to encourage banks in the core to lend to banks and businesses in the periphery – this fits with the theory of the negative deposit rate which should encourage a search for yield. Rebuilding the cross border system in the eurozone remains a huge task.

Another potential question which arises is whether the end of sterilising purchases made under the Securities Markets Programme (SMP) will raise any legal issues or challenges in Germany and whether it will impact the judgement of OMT sterilisation.

In the end, the ECB has made its play and will likely now give it time to pan out. It will continue to provide dovish statements and may even talk up asset purchases in the future but it will urge patience in waiting to see if these measures have the desired impact.

Handelsblatt asks, "Where is the inflation?"

That’s today’s front page of German daily Handelsblatt, with the headline asking “Where is the inflation?”

A stark reminder of what remains a key issue in German (and therefore European) politics. We could barely ever imagine such a front page in the UK, particularly when annual inflation is running at only 1.6% (August 2013).

Inside the paper there is a ten page section discussing the issue. Essentially, Handelsblatt is questioning why, when there has been such significant money printing and low interest rates in the eurozone, is there yet to be inflation. This is put in context with a comparison to the hyperinflation of the 1920’s Weimer Republic, another reminder that this episode in the country’s history continues remains firmly embedded in the German psyche.

The discussion itself is obviously hugely technical, but the paper’s explanations for why inflation is (yet) to show up is quite telling about the debate in Germany.

• Central banks only measure consumer prices – the paper essentially suggests that the usual metric of inflation, the Consumer Price Index (CPI), does not fully capture the real inflation rate since it does not include things such as asset prices and house prices.

• The increased money supply is not feeding through to the real economy – the suggestion here is that, although money supply is being increased significantly, it is not feeding through to the real economy because banks are not lending out and because people and companies are saving more. It could also be down to the fact that banks, companies and the government are deleveraging (paying off debts and reducing their size) in order to become more stable in the wake of the crisis. For these reasons, the money created has stayed within the financial system rather than leaking to the wider economy and hitting inflation – at least not yet.

• Still too early to fully judge the impact of the ECB’s policies – this seems to be linked to the argument above but the paper suggests that the low interest rates and other non-standard measures which the ECB has undertaken (such as unlimited long term loans) are yet to have their full impact. The suggestion seems to be that, as the economy recovers, the true impact of the policies will become clear.

• So, what will happen? The paper concludes that these policies are likely to have some impact and that inflation will show up at some point.

Although this is clearly just the view of one paper, the tone and line of argument here is quite telling.

Clearly, there is still concern that inflation will show up and even that it may already have and be going unnoticed. This fits with recent concerns raised by the Bundesbank that low interest rates and loose monetary policy can pump up financial bubbles and set the scene for the next crisis.

This debate is here to stay in Germany and Europe. As the ECB considers further long term lending operations (LTROs), how to deal with actions of other central banks and the large divergence in growth between Germany and some struggling countries, it could come to the fore once again. 

ECB preview - is the ECB already seeing the limits of its new communication policy?

The ECB holds its monthly meeting today in what may be seen as the most positive eurozone economic environment for some time.

Having previously been earmarked as a meeting which could see a further rate cut (a prediction which has evaporated due to more positive economic data) this meeting is now likely to be dominated by ECB President Mario Draghi’s attempts to restate his new communication policy.

July saw the launch of this policy, focused on ‘forward guidance’ (forecasting future interest rates) and the potential publishing of minutes of ECB meetings, in an attempt to add a new tool to the ECB’s monetary policy arsenal. However, in recent weeks there have been indications that the ECB may already be seeing the limits of such an approach.

Forward guidance struggles

• As the chart above shows (via Commerzbank) indicators suggest that future overnight short term interest rates are expected to increase, while the borrowing costs for short term bunds and other core eurozone countries have also been creeping up. Expectations of an ECB interest rate increase have also been brought forward significantly, whilst the euro has also been strengthening recently.
• Much of this is off the back of recent good data from the eurozone, of course a positive, but given that the data is far from comprehensive and problems still abound for the eurozone its clear the ECB is not yet ready to change course.
• Of course, given that it is early days for this policy and that the rate moves have been small it is impossible to draw a definitive judgement just yet, but there are signs of limits to the policy.

ECB Total Balance sheet (€m)

• The ECB is also seeing its monetary policy being effectively tightened as the Long Term Refinancing Operation (LTRO) loans are repaid, with its balance sheet shrinking (chart above) to its smallest size since the start of 2012, and no signs of banks increasing lending to the real economy to compensate. Again, a positive indicator but not quite what the ECB might have wanted with the introduction of a new tool indicating loose monetary policy for some time.
• External conditions have also not been helping. The Bank of England is facing a similar issue, for similar reasons, while the US Fed has announced the prospect of slowing down its Quantitative Easing programme – the much maligned ‘tapering’. This has unsettled markets and threatens to reduce liquidity globally – so far much of the pain has been felt in emerging markets, but it could yet spill over into peripheral Europe, hitting demand for government and corporate debt and pushing up borrowing costs.

Backing away from minutes

The other part of this new communication strategy was a move towards publishing minutes of ECB Governing Council meetings, with many ECB members issuing support. However, there are indications that this may also come up against problems (as might have been expected).

The concern has always been that divergent views within the ECB (read, from the Bundesbank) would make ECB minutes more trouble than they’re worth. Over the past few weeks we have seen the Bundesbank use its monthly bulletin to warn that rates could still increase and attempt temper the commitment under ‘forward guidance’, while its President, Jens Weidmann, has also warned of the potential "pressure" on decision makers if minutes were published. Additionally, comments from Austrian Central Bank Governor Ewald Nowotny suggested that the ECB might be backing away from the plans (such interventions are rarely made without some approval from the ECB hierarchy as we saw when minutes were proposed):

“My personal view is that of the founding fathers of the ECB…They were very cautious to secure the independence of the ECB by not giving minutes on the individual votes of the members of the Governing Council.”

All these factors then, have worked to expose some of the frailties of the ECB’s guidance policy, not least that it remains much more vague and unfocused than those employed at the US Fed and the BoE. The ECB (with some good reason) is hesitant to get into specifics over the timeline and conditions for keeping rates low – this will clearly hamper the usefulness of this policy tool (and brings us back to questions about how many tools the ECB really has at its disposal).

In fact, there is already talk of using another LTRO to bolster this policy and help stop any upward movement in rates, although given the limited impact of the initial LTROs (beyond avoiding a bank funding crisis) this may not help much.

All that said, the ECB is unlikely to drop its new communication approach in the near future, leaving Draghi the unenviable task of continuously restating the ECB’s commitment to this policy – expect this to begin in earnest at today's meeting.

German election update: Lucke hits back

An interesting story caught our eye in today's Welt concerning next month's German elections. Bernd Lucke, the head of the anti-euro Alternative für Deutschland party (seemingly undaunted by a recent attempted assault on his person) has written a letter to German President Joachim Gauck asking for access to documents in which the German government has simulated different scenarios to save the euro, citing Germany's freedom of information laws. The move fits with the party's theme of "having courage for the truth" (Mut zur Wahrheit), which it accuses other German political parties of lacking.

This comes after the same request addressed to the Chancellery, Bundesbank and German banking supervisor Bafin was rejected on the basis that the information is held by the eurozone's network of central banks, and therefore falls outside the scope of German law. Lucke has criticised such "questionable" behaviour on the part of German officials, while noting that the Bundesbank's refusal to reveal the information shows that it is de facto supporting the German government when it should be a politically independent actor.

While we're not expecting the information to become public soon, the documents would certainly make for interesting reading as they would reveal how the German government assessed the costs of a breakup, and therefore whether its subsequent policies for dealing with the crisis have indeed been 'alternativlos' as Merkel has argued, or whether alternative policies were jettisoned due to the short-term political and/or economic implications.

A shift towards greater transparency at the ECB?

As we reported in today’s press summary, there has been an interesting development in the push for greater transparency at the ECB.

In a joint interview with Süddeutsche Zeitung and Le Figaro, Benoît Cœuré (BC) and Jörg Asmussen (JA), ECB Executive Board Members, both supported the longstanding call for the ECB to publish the minutes of the meetings of its Governing Council, saying:

BC: “Transparency is important for the effectiveness of monetary policy and for trust in the central bank. There was a time when the ECB was ahead of the curve in its communications and transparency as first central bank with regular press conferences by its president. Now the ECB is the only large central bank that does not publish its minutes of meetings. There is a demand in society for transparency and accountability. Therefore, I personally think that the ECB should start publishing its meeting minutes soon.”

JA: “The minutes should include who voted for what, and the reasoning behind that vote. Publishing the minutes will sharpen the European mandate, because the ECB will then have to explain why its decisions are in line with the European mandate.”

BC: “The other side of the coin is, as Jörg has said, that the Governing Council has a European mandate. The governors of the national central banks come here in a personal capacity – they do not represent their institutions or their countries – and should be accountable for what they do.”

This is something which many (including ourselves) have supported for some time (see here for a House of Lords report from 2003 which provides an interesting discussion of the issue), particularly during the crisis where the opacity of the ECB (on issues such as bond purchases, legal documents and potential policies) has at times caused confusion and uncertainty. It has also hampered the accountability of the ECB and its members despite the bank playing a central role in the crisis resolution.

But all that has been true for some time, so why might the ECB be changing its tune now? The most likely reason seems to be a switch in the communication policy of the ECB, which began last month with the change to ‘forward guidance’ (forecasting future interest rate policy). Although, this did little to change the substance of ECB policy (frankly everyone knew rates would be low for some time) it is a clear shift in tactics and rhetoric. Publishing minutes fits well with this new approach for a few reasons:

• It allows the ECB to provide further detail about its decisions and what the key motivating factors were.
• It highlights the discussions of various options which the ECB may be considering to combat the crisis, this could help telegraph future action and impact market sentiment without the need for an actual decision to be taken.
• It will demonstrate the weighting of support within the council for certain policy options, again providing further detail on likelihood of future actions but also the strength of feeling on various policies (i.e. a clearer picture of the dovish or hawkish nature of the council).
• Can be used to communicate concerns to the market and other policymakers which may not have warranted inclusion in the monthly press conference of the ECB President Mario Draghi. Furthermore, if published with a delay, can allow for reflection on the impact of different policies.
• Essentially, it provides a further tool in the arsenal of the ECB to help communicate with markets and achieve policy goals. As we have noted, the ECB has recently looked increasingly policy constrained and so any additional tool would likely be welcome.

All that said, the impact of this tool should not be overplayed. It is ultimately a small aspect of overall ECB policy, its main benefit is that it can provide further nuance to some of the blunter instruments (interest rates etc.). From an outside perspective it could provide a much needed insight into the decision making process – although this will ultimately depend on the credibility of the minutes (will they really reflect the true nature of the discussion) and when they are released.

On top of this, FAZ is reporting this afternoon that the ECB and national central banks will publish more details on the notoriously secretive Emergency Liquidity Assistance (ELA), although the article seems to suggest they may only release the framework or rules of ELA rather than details on its practical use and application. Still this would be a welcome, if small, step towards transparency.

Some steps towards greater transparency then, however, the underlying motivation seems more likely to be to give the ECB another tool in its new communication strategy rather than increasing accountability as an end in itself. Either way greater insight into the opaque institution playing a key role in the crisis should always be welcomed.

German Constitutional Court live blog: One of the most important cases in the Court's history?

The German Constitutional Court in Karlsruhe

The German Constitutional Court’s (GCC) hearings into the legality of the ECB’s actions to combat the eurozone crisis – and specifically the OMT bond buying programme – kicked off this morning. (See here for the background). In a front page leader, FAZ describes the case as one of the “most important” in the court’s history.

Public opinion in Germany is mixed, with a Forsa poll for Handelsblatt finding that 48% of Germans hope that the Court will put a stop to the OMT, while 31% believe that the complaint against the ECB is unjustified. As we noted in our flash anaylsis on the topic yesterday, the GCC can't actually stop the ECB. At worst, it could remove Germany from the ECB's bond buying programme and probably, therefore, from the eurozone itself. (A poorly phrased poll question, then, but a very telling result nonetheless).

With Schäuble, the German Finance Minister, and the ECB's positions already well known (that OMT is within the Central bank's mandate), we can safely say that the highlight of the day will come  from the opposing side, in testimony of Bundesbank President Jens Weidmann. In terms of their specific grievances, it will be the first time we will hear a detailed, public explanation of where the Bundesbank stands on this issue, while the tone of Weidmann's comments will also be interesting. Will there be any more Faust references we wonder?

Check our twitter feed for live updates from Karlsruhe throughout the day. We will also continue to update this blog as things develop.

17:45

Bundesbank President Jens Weidmann has now had his say - and again his points were very much as expected (his full statement is here but only in German for now).

• Warned that ECB OMT blurs the line between monetary and fiscal policy - this makes it more difficult to achieve price stability and spreads solvency risks amongst eurozone countries, but does so without any parliamentary or democratic approval.
• Pushed for a narrow interpretation of a central bank's primary mandate, with a complete focus on price stability.
• Suggested that the OMT does represent potential losses for taxpayers, arguing that if the ECB took on significant amounts of risky debt, it may face large a loss which it cannot absorb and may require aid from member states.
• Argued that even secondary market purchases can overturn the force of market discipline and undermine fiscal autonomy.
• Issued a warning over the interpretation of the real-risk premiums for bonds, which he suggested was very subjective and dependent on future policies.
• Accepted that the inflation outlook in the eurozone fits with price stability at the moment, but still expressed serious concern about comprising the ECB’s focus on this.

It seems to us that, of the two sides, Weidmann had the tougher case to make. Ultimately, as much of the above shows, he is forced to consider hypothetical scenarios and potential worst cases. These are undoubtedly risks that should be highlighted, but it does leave one feeling that his argument is slightly less clear cut than Asmussen’s.

Having heard the key testimony of both sides, we still expect the court to side with the ECB, but with some caveats (although how strict they will be is very much up in the air). Of course, this could still develop more tomorrow. 

16:20

Asmussen has now concluded his testimony and subsequent Q&A, and the ECB has also helpfully put a transcript on their website. Here are the key points he made:

• the OMT will have the ability to sell bonds as well as buy them, and it will not take them off the market permanently, unlike its forerunner the SMP (in fact Asmussen repeatedly highlighted the differences between the two);
• the OMT is pari passu (equal to) other creditors,
• the OMT seeks only to reduce unwarranted interest rate spikes and is not aimed at harmonising financing conditions of member states,
• the ECB would react if a country were to try to game the system by converting all its bond issues to a short maturity (of up to three years), but that in any case markets themselves would "see through and deny" such attempts,
• the only risks associated with the programme stem from countries operating "un-sound" policies, but that those states that fail to comply with the OMT's conditionality could be faced with the prospect of having to leave the eurozone.

The comments were more or less as expected. However, there are a couple of interesting points. First, the fact that the bonds purchased under the OMT will be judged at market value suggests that, if they are purchased and then decline in value, the ECB could be facing losses on its balance sheet. A tricky technical and political issue. Second, the point about 'un-sound' policies leaves us feeling slightly uneasy. Its clear that even with an ESM bailout programme, implementation may not be up-to-scratch. Meanwhile, it also highlights the clear link that would be established between ECB policies and the fiscal (and other) policy of national governments. This surely raises questions about the ECB's independence.

Asmussen also admitted that the policy did have de-facto practical limits given that it will only purchase short term debt, as reported over the weekend.

15:10

Handeslblatt reports that Philip Rösler, the German Minister for Trade and Vice Chancellor is coming under increasing pressure from his own FDP party to take a stand against the ECB, following the Handelsblatt/Forsa poll showing that almost 50% of Germans hope that Karlsruhe will stop the ECB’s OMT programme (despite this actual course of action not being possible, see blog intro above on this).

Frank Schäffler, the financial expert of the FDP parliamentary group, told Handelsblatt Online that "Working towards a market-economy is widespread among the followers of the FDP. Liberals know that prosperity cannot be printed from the ECB.”

The irony of clinging on to central bank independence, while using political pressure to change the course of the ECB is not lost on us - nor on Rösler it seems, who said: “We must not allow this course toward stability to be broken up through the the attempt to exert influence on the European Central Bank.”

13:55

These comments from ECB Executive Board member Yves Mersch seem to confirm our feelings that the ECB is trying to have it both ways over its refusal to publish the OMT documentation (see 13:30):

Mersch: "controlled uncertainty on the OMT is necessary"
— zerohedge (@zerohedge) June 11, 2013

13:40

Germany's new anti-euro party Alternative für Deutschland has just put out a press release citing Professor Joachim Starbatty - one of the original plaintiffs in the case and now one of AfD's top candidates in September's elections - warning that under the OMT, German taxpayers will be responsible for liabilities that are "no longer the responsibility of any government or parliament". The party is clearly hoping the publicity around the hearings will boost its poll ratings.

13:30

Asmussen is clearly channelling Draghi in his comments below. The ECB's continuing refusal to simply publish the legal documents relating to the OMT is at best strange and at worst downright obstructive. It does beg the question: what are they trying to hide? Maybe nothing, but at the very least it seems they are trying to have the best of both worlds. By refusing to reveal the exact terms and conditions, the ECB can try to address German concerns over the extent of the OMT (as we have seen them doing in the run up to this case) while also being able to continuously reassure markets that the scheme is in fact "unlimited".

Such a balancing act is tough to pull off and may add to confusion if it breaks down. Some transparency would be welcomed. It needs to happen at some point, who's to say it would be better revealing the legal documentation just when the OMT is being tapped, surely by definition that would be a period of crisis?

13:05

The ECB's Jörg Asmussen is up now making the point that the ECB would actually adopt a legal ordinance before any bonds were purchased:

#ECB's Asmussen: #OMT Documentation Ready For Publication When Needed. OMT Documentation Can Be Published Within Days
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

#ECB's Asmussen: #OMT Cannot Be Activated Before Publication Of Guidelines
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

11:15

German Finance Minister Wolfgang Schäuble has spoken, and as expected, he backed the ECB:

German FinMin Schäuble: #ECB Independence Gives It Wide Scope For Decision-Making
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

Schäuble tells court government sees no evidence that the ECB has overstepped the bounds of its mandate. #karlsruhe
— Michael Steen (@michaelsteen) June 11, 2013

German finance minister Schaeuble argues the court shouldn't even be considering the OMT case, as they've no jurisdiction there. #karlsruhe
— Jeff Black (@Jeffrey_Black) June 11, 2013

ECB gears up for German Constitutional Court scrutiny

This is set to be an important week for the ECB and therefore the eurozone.

As we noted in a flash analysis this morning, the German Constitutional Court (GCC) will hold a hearing on the 11 and 12 June focusing on whether the ECB’s policies have infringed either its own or the Bundesbank’s mandate, and if these have created fiscal risks without democratic approval.

The focus of the case will be the OMT, the ECB’s flagship bond buying programme, the announcement of which is widely seen to have played an important role in easing the eurozone crisis.

Why is the case important?

1. Highlights the tensions at the heart at the eurozone: the case is a microcosm of the wider debate as to whether Germany is willing and able (in terms of legal constraints) to do what is seen as necessary to save the eurozone. It also puts pay to the idea that once the German government has a fresh mandate following September’s election, there will be a swift move towards more eurozone integration – these legal questions will remain and will continue to crop up.
2. Pits the ECB against the Bundesbank: linked to the point above but this is also a very awkward division within the eurozone architecture, as personified by the confrontation of the ECB's Jörg Asmussen on one hand and Bundesbank President Jens Weidmann on the other. The Bundesbank will likely have to keep implementing ECB policies despite it now being well known that it fundamentally disagrees with them. 
3. Further constraints on crisis policies: in the end, the GCC will likely rule in favour of the ECB. However, as with previous rulings, it could set out red lines and restrictions to protect the German Constitution – this could throw a new element of risk into the crisis.
4. Increased transparency on ECB actions: this is something which we, and others, have been calling for for some time. One benefit of the case is that it has increased scrutiny on the OMT with the ECB now admitting it may be forced to published the legal documents which will layout the practical functioning of the OMT. This could generally be beneficial, although if markets do not like what they hear then it could actually contribute to market jitters.

With this final point in mind, there was an interesting story in FAZ over the weekend, which suggested that the OMT is not in fact as “unlimited” as had first been thought. Indeed, FAZ claimed that it is limited to €524bn, since the ECB will only be allowed to purchase debt with maturity between one and three years.

This constraint was always known, as we noted when the programme was announced. The cap essentially arises because this is the total amount of debt from Italy, Spain, Ireland and Portugal (i.e. those countries most likely to access OMT). The cap doesn’t seem to be hard and fast then, since countries could simply issue more short term debt. However, this does come with its own risks (another point we raised at the time), and the ECB has suggested it would look to prevent such an approach, although it hasn't said how.

Handelsblatt goes even further, suggesting that there is an internal rule which limits the ownership of bonds by the ECB to 50% of the given market, suggesting this means the cap is even lower at €260bn.

But even if the cap isn't quite what it’s cracked up to be, it’s very interesting that the ECB itself is selling it to the GCC as a limit. Clearly, there is some concern about the outcome on its part.

Despite a definitive ruling not expected until the end of the summer at the earliest, and more likely after the September elections, there could well be plenty of interesting revelations and disputes aired over the next few days, which we will of course be covering in detail.

More of the same expected from the ECB despite eurozone economic malaise

The ECB holds its monthly meeting tomorrow. Below we look at the main topics of discussion, with the ECB weighing some important decisions.

Could the ECB cut its main interest rate again?

• Possibly. It is certainly considering it. As with last month, growth and inflation have remained subdued, providing further incentive and scope for the ECB to cut rates.
• There has not been a significant downturn on either front however, meaning many do not expect further action.

The ECB is considering a negative deposit rate
Most reports suggest the ECB Governing Council is split on this issue. At the least this means it is unlikely to push ahead with it. We also believe the problems and complications outweigh the benefits. There has been much written about this but below we summarise the key points.

Logic: banks are now charged for holding large excess reserves (deposits) with the ECB, this will hopefully encourage them to make loans on the interbank market and make more loans to the real economy rather than holding the money at the ECB.

In favour:

• Banks and investors look for higher returns and begin lending cross borders again. This aids financial integration and could help tackle other issues such as the large Target 2 imbalances.
• Increases the amount of times money is circulated through the economy (the velocity of money) as lenders try to avoid getting stuck with excess cash. This could in theory help boost inflation and growth.

Against:

• Contrary to prevailing logic it could actually cause a drop in liquidity. As excess reserves become more expensive banks begin repaying loans they have taken from the ECB. All the while they are deleveraging (may even speed it up), causing less money to flow to the real economy.
• Rates could actually rise for a number of reasons. Larger number of weaker banks forced onto the interbank market. Banks may simply look to pass on increased costs to consumers.
• If banks do not pass on costs or deal with them, then profits will be hit – in many cases they are already worryingly low.
• Could increase the flood of money to safe assets, particularly from the core eurozone countries. The return on these would become even more negative, increasing their costliness and driving divergence with the rest of the eurozone.
• The large money market fund industry, which plays an important role for liquidity in bond markets, could struggle to stay afloat since it relies on small positive returns on safe short terms assets (see above points).
• The euro is likely to weaken, this combined with the other effects could cause a large outflow of cash to other parts of the world, exacerbating problems.

What about all the talk of boosting lending to small businesses?
This focuses around the creation of a new market for securitised loans to small businesses. The logic being: banks make these loans, package them together into securities and then sell them on to other banks and investors. There is a clear demand for quality assets which provide a decent return meaning there could be demand for such securities.

However, the ECB has backed away from grand plans on this issue. As we pointed out previously it was always very hesitant about purchasing such securities itself, with the Bundesbank in particular opposed to such action.

More of the same seems likely
With things ticking over the ECB is likely to hold off on any further drastic action at its meeting tomorrow. It will continue to emphasise that monetary policy will remain loose for some time (the concept of forward guidance which it began to adopt last month to some extent). It may also put more flesh on the bones of schemes to work with the European Investment Bank (EIB) to boost lending to small businesses. Some easing of the collateral rules as we predicted last month is also a definite possibility.

As we’ve said before, the ECB continues to look constrained. It does of course have a few more tools, however, they are in many cases quite extreme and have potential side effects. These are best suited to very extreme scenarios (euro break-up) rather than the wider malaise and long term endemic crisis which the eurozone now faces, particularly given that often (as we are now seeing with banking union) any ECB action sparks complacency and inaction on the part of politicians.

When ideology meets economic reality (part III): Germany squabbles over the Financial Transaction Tax

The Bundesbank, The Deutscher Aktieninstitute (DAI), and even EU civil servants from the 11 participating countries have all warned against the FTT in its current form.

Today saw yet another German voice raised again the tax – this time from the very party that is meant to be its greatest champion. Nils Schmid, Baden-Württemberg's Minister of Finance – from the German social democrats (SPD)— wrote a letter to German Finance Minister Wolfgang Schäuble condemning the FTT in its current form as “rubbish.” Ouch.

Schmid’s intervention, says that "If the financial transaction tax is implemented as is currently planned, initial estimates show that it is likely to have a serious impact on certain segments of the market (money and capital)." He then calls for a “proper configuration” of the FTT.

So why is this important? Twofold:  first, it shows that in light of the overwhelming evidence of the negative economic impact of the FTT in its current form, the support for the proposal is quickly evaporating.

This now extends to the German political parties that have strongly endorsed it. Remember, the FTT is one of the SPD’s main campaigning issues, and served as the party’s quid pro quo for accepting the EU fiscal treaty. Although Schmid caveated his position, saying that he is not opposed to the idea of a FTT in theory, the point has most definitely been made.

Secondly, the FTT controversy has legs to become battleground ahead of the German elections in September. It is an issue that may split politics, both, within the parties and on a national level.

Officially, Schmid’s letter was met with a standard diplomatic line from the German Finance Ministry – which says it is taking concerns raised by Schmid and German banks “seriously.” They won’t say so in public, but the German finance ministry was most likely nodding approvingly…

Meanwhile, deputy chairman of the FDP parliamentary group ,Volker Wissing, saw his opportunity to strike – and took it, saying that Schmid's letter shows with which "naivety" and "rose-tinted blindness", the SPD had driven the demand for a financial transaction tax.

So far the SPD have remained stumm on Schmid’s intervention. But watch this space. If influential figures within SPD are the latest to start make noises about this, then surely, the Commission’s proposal cannot stand?

ECB increasingly likely to cut rates but running short of tools to help the eurozone economy

The ECB looks set to cut its main interest rate by 0.25% to 0.5% on Thursday (while keeping the deposit rate at 0% due to concerns about distortionary effects of negative rates).

Why is the ECB considering cutting rates?

• The obvious answer is that the crisis is clearly dragging on and the eurozone economy is struggling. But, that has been true for some time, so why now?
• Economic activity has been particularly bad (see right hand graph below), while forecasts have been continuously downgraded.
• In particular, annual inflation has dropped well below the ECB’s target of 2%, while unemployment has continued to rise (left hand graph below, click to enlarge).

Will it have any impact?

• Not really. On the margin it will help reduce costs for those banks which borrow heavily from the ECB and consumers with variable rate loans and mortgages – but the impact will be very limited.

• The usual mechanism through which a rate cut is transmitted to the market is broken. See for example the overnight lending in the eurozone. It remains at a very low levels. That said, rates are also at record lows. Why is this? Well, most likely because only the strongest banks are borrowing on these markets. For this reason the cut will not filter through to where it’s most needed since lending rates are already completely detached from it and focus more on the risks of the banks involved.

• As has been well documented, rates in the south and the north are also significantly different, particularly in terms of lending to businesses. Clearly, these have also diverged from the current ECB rates which are already incredibly low. Cutting further is unlikely to impact this.

What other tools does the ECB have?

Communication: ECB indicates willingness to keep monetary policy loose and step in to aid markets if needed. This has been used effectively by the Fed.
Probability: High, especially in coordination with rate cut.
Effectiveness: Minimal boost since it is already being pursued to some extent, more to reassure markets.

Easing collateral rules: ECB widens the range of assets which it accepts as collateral in exchange for its loans. May also decrease the 'haircut' applied to the value of the loans (thereby increasing their worth as collateral). This is likely to be targeted on SME loans and securities made up of SME loans.
Probability: High, if not this month then in June, particularly if economic data continues to be poor. Effectiveness: Limited, could help bank funding but unlikely to boost SME lending significantly. More risk taken onto ECB balance sheet, likely to widen divisions with Bundesbank. Has been done previously and had little impact.

Outright purchases of SME loans and securities: ECB purchases securities of bundled SME loans, similar to the purchases it made under the Covered Bond Purchase Programme and the Securities Markets Programme.
Probability: Very low. Draghi has previously suggested he sees it more as the job of institutions such as the EIB to help SMEs. Furthermore, the level of SME ABS is limited since they rely heavily on bank loans for funding (another reason why the ECB believes a rate cut could help, at least in theory).
Effectiveness: Limited, especially given that the market for such products is not huge. It would also increase the risk taken directly onto the ECB balance sheet (more so than easing collateral) and would provoke an outcry in Germany for overstepping the acceptable level of central bank intervention. Furthermore, such direct purchases are much harder to unwind than loan related policies which expire naturally, selling off these assets will be tough.

A version of the UK 'Funding for Lending' scheme: not really an option for the ECB at this time, contrary to popular belief. The various national regulations and structures aside it is practically impossible since the ECB already applies full allotment (unlimited lending).
Probability: Very low.
Effectiveness: Potentially counterproductive as the ECB would need to end its programme of full allotment in order to then make liquidity dependent on the amount of loans made by banks.

These are to name but a few options being reviewed currently. Other options such as working with the European Investment Bank to promote SME lending would need political assistance, while options such as 'Quantative Easing' aren't viable for the ECB, as we discussed here.

So for all the talk of the rate cut, it will likely have a very minimal impact. The ECB could look to combine it with other policies but the painful reality is that, when it comes to boost lending to the real economy, the ECB has very few options. Constraints from the Bundesbank and concerns over the progression to banking union mean the ECB will likely continue to put the onus on governments to make reforms to boos the economy.

When ideology meets economic reality (Part II): Bundesbank says EU financial transaction tax could make banks more reliant on cheap ECB money

As was made evident by the internal memo about the EU financial transaction tax (FTT) - that we exclusively published yesterday - there are plenty of concerns amongst the supposed champions of the idea.

Today, another heavyweight institution raised the alarm: Die Bundesbank.

This could come across as a niche issue, as with most central banking issues. But as with most central banking issues it could also be of vital political importance in Germany.

As we noted in our flash analysis on the UK’s FTT challenge last Friday, the proposal could have a worrying impact on ECB monetary policy:

Increasing banks’ reliance on cheap ECB cash: With central bank lending exempt from the FTT but the market channels to obtain liquidity hit hard, the FTT actually provides a perverse incentive for banks to borrow cheap money from the ECB and central banks. This runs completely contrary to efforts in the Eurozone to get banks off ECB liquidity and could instead further entrench market fragmentation.

This is a point which has been rarely made in the FTT debate but whose implications for Germany - already deeply worried about weak banks over-reliance on cheap ECB funding - could be huge. Sure enough, Bundesbank President Jens Weidmann today raised concerns over this very issue. In a speech in Dresden, he said:

The introduction of the tax has basically been decided but the unintended side effects could be considerable: In its currently envisaged form, the tax will cover asset-backed money market funds, so-called repo firms, and significantly damage the repo market. However, the repo market has a central role in ensuring the equalisation of liquidity between commercial banks.

If it does not function correctly, the corresponding institutions are diverted onto the Eurosystem, and the Central Banks remain massively and permanently involved in the liquidity equalisation between the Banks.

From a monetary policy perspective, the financial transactions tax in its current form is therefore to be viewed very critically, and it shows how important it is to precisely test a regulatory scheme before its introduction. This however takes a bit of time.

Exactly as we warned. More banks - particularly in the southern eurozone - borrowing from the ECB would not only increase German exposure to the crisis (ultimately, the ECB is taxpayer-backed). But it also negatively impacts the independence of ECB monetary policy since it will hamper the central bank's ability to exit its abnormal liquidity operations and therefore impact its ability to control policy.

This also gets to the heart of what we (and others) have been saying about the FTT.  Although the headline goals and figures look nice, the multitude of side effects (for financial markets, for pensions and even for central banks) mean the real impact of the FTT is far beyond what is envisaged or what can be effectively managed by the regulation.

Watch this space. This could become a big issue in Germany.

This is getting personal: Handelsblatt likens ECB President Mario Draghi to the Little Corporal

Update 15:28:

Mystery solved. The good folks at Handelsblatt tell us that it's indeed Karl XIV Johan of Sweden (original H/T @Presseurop). Apparently, there's no particular reason for why they chose the Frenchman-cum-Swedish King, apart from seeking to depict Draghi as a 19th century sovereign.

Update 11:40AM:

People have pointed out to us that, in fact, it's not Napoleon Bonaparte that is depicted. Handelsblatt isn't exactly clear about who Mario Draghi has become on its front page, so we're left guessing. The two strongest contenders are Napoleon III – founder of the Latin Monetary Union (and who was defeated by the Prussians in 1870) and Karl XIV Johan of Sweden (who was one of Napoleon's generals but after being imported to Sweden to serve as a King, he eventually ended up fighting the French). The latter would imply a very high level of assumed knowledge. to say the least. We wonder what our readers think?

Today's frontpage of heayweight German daily Handelsblatt depicts ECB President Mario Draghi as Napolean, with the subtitle

"The toxic gift. How ECB President Mario Draghi is saving the euro while ruining savers".

 The article inside goes on to argue that: 

“as a result of the cheap money policies (…) new bubbles are emerging, insurers are suffering and savers threaten to lose their savings" 

It quotes former ECB chief economist Juergen Stark as saying 

“central banks must be the trusting anchor of the paper money regime. When they don’t do this and are being overburdened with all kinds of new tasks, this fragile system is under threat.”

The Napoleon reference probably has several different levels to it, but one thing is clear: it's not meant to be a compliment. Although German fears of inflation and lose money are well known this is getting personal.

Merkel caught in the middle between the Bundesbank and the ECB

In her traditional news conference following the summer recess, German Chancellor Angela Merkel walked a fine line in questions about the eurozone crisis, having to maintain a delicate balancing act with regards to different elements within her governing coalition.

For starters, she has to contend with the increasingly fractious rhetoric from the CSU – the Bavarian sister party of her own CDU – on the eurozone (see here and here for examples). The latest example being Bavarian Prime Minister Horst Seehofer’s argument that the €190bn cap on German liability imposed by the German Constitutional Court in its ruling on the ESM and fiscal treaty last week should apply to the euro-rescue effort as whole, including the ECB’s new OMT bond purchasing programme. However Merkel has rejected this interpretation on the basis the two are not linked. Speaking earlier today, she told reporters that:

“If the ECB determines that monetary transmission has become difficult, then it must take measures to ensure price stability - it is not up to us to set it limits.” 

Seehofer later confirmed that “this is the only issue which we interpret somewhat differently than in Berlin”, adding that it was nonsensical for the Court to cap Germany’s liability at €190bn only for “it to be suddenly increased by many multiples through other means”.

On the other hand however, Merkel did not issue a statement of blanket support for the ECB’s actions, adding that Bundesbank President Jens Weidmann’s recent interventions – in which he has been fiercely critical of renewed ECB bond-buying were “understandable and always welcome”, a statement widely interpreted in Germany as a subtle rebuke of Finance Minister Wolfgang Schäuble’s comments in an interview with Frankfurter Allgemeinen Sonntagszeitung yesterday in which he criticised Weidmann for his public dissent, arguing that “I'm not sure that making this debate semi-public helps to build confidence in the [European] central bank.”

Merkel is in a tough position because, having invested so much in the euro-rescue, she cannot afford to oppose the ECB’s ‘big-bazooka’ strategy. At the same time however she cannot allow Weidmann – whose views are widely respected and shared by the German public – to become completely isolated for fear this would provoke a substantial domestic backlash.

How long Merkel will be able to keep her fractious coalition together on one hand while also keeping the German public – whose support for the EU and euro has hit an all-time low – onside remains to be seen, especially in the event of unforeseen developments such as Germany actually suffering direct losses on its loans to Greece and/or losses on ECB holdings of Greek debt.

The death of the Bundesbank? Germans come out swinging against ECB bond-buying

Although Jens Weidmann may have been alone on the ECB executive board in opposing yesterday’s ECB decision to buy government bonds, he looks to have the full-force of German public and media opinion right behind him. Over the last 24 hours, the German media, with surprisingly few exceptions, has fired a broadside against the ECB. No holds barred. Mario Draghi may have pleased markets, but he now has a very frustrated Germany – whose taxpayers are implicitly underwriting his institution (and the euro) – on his tail.

One of the most interesting reactions came from the Bundesbank itself, which unusually issued a public statement which ran directly contrary to the ECB’s decision. A Bundesbank spokesperson said:

Weidmann regarded the bond purchases “as being tantamount to financing governments by printing banknotes,” adding, “The announced interventions carry the additional danger that the central bank may ultimately redistribute considerable risks among various countries’ taxpayers.” 

Süddeutsche Zeiting’s Marc Beise has a blistering piece, crediting “Weidmann’s persistent opposition” as the reason why the ECB is ‘only’ buying short-term debt. But, goes on to argue, “Saving the euro is worth a lot of effort but there are two important limitations. A euro rescue at any price can be a disaster economically, that is the red line that must not be exceeded. The other limit is the law: never in a rules based community can the end justify the means. A Euro-community based on breached contracts will always be based on fragile foundations. On Thursday, the ECB has unfortunately crossed both these red lines.”

Meanwhike, Die Welt led with the headline “Financial markets celebrate the death of the Bundesbank”, adding, “For Germany, the nightmare begins. There it was: the word that everyone was waiting for: unlimited…ECB President Draghi brazenly breaks with the principles of German monetary policy.” Bild runs with a similarly eye-catching headline, warning against "Draghi's blank-cheque for debt-states".

FAZ's editor-in-chief Holger Steltzner also took a strong line, saying, “In the eurozone there isn't any division any more between monetary and fiscal policy…We should be curious to hear what the German Constitutional Court thinks about that.”

The warning on the German Constitutional Court is an interesting one (a topic we’ll discuss in future posts) but some politicians went even further, with Hessen Europe Minister Jörg-Uwe Hahn of the FDP and CDU’s Klaus-Peter Willsch (already the initiator of one of the ESM complaints to the German Constitutional Court) calling for the German government to seriously consider taking the ECB to the European Court of Justice for violating its legal mandate.

The ECB wasn’t the only institution on the receiving end though, with the German government and Chancellor Merkel also taking flak. Handelsblatt's deputy editor in chief, Florian von Kolf wrote, “Today is a black day for democracy…Merkel is silent…seemingly happy to have been partly relieved from her here Sisiphus task to save the euro”. DPA reports that SPD parliamentary leader Frank-Walter Steinmeier argued that the ECB’s decision is the “documentation of Chancellor Merkel’s failure...[while Weidmann] protests but Merkel gives the green light”, while the Green party decribed the CDU and FDP opposition as “hypocritical” since it was their failure to take any significant decisions on the crisis which forced the ECB to act.

We’ll continue to cover reaction throughout the day on the blog so stay tuned, but we can’t help but recall all those times we warned that saving the euro at any cost could drive a wedge between countries rather than bringing them closer together…

Germany faces some tough decisions on the ECB

As the next ECB meeting approaches on 6 September, the debate about potential ECB intervention is heating up. This past weekend was particularly interesting with two key German players weighing in with their views – even more importantly these views turned out to be increasingly divergent.

German ECB Executive board member Jörg Asmussen (on the right of the picture) revealed more details on potential ECB intervention yesterday, saying, “Under the framework of the new programme, the ECB will only buy bonds with short maturities,” adding the caveat that, “The whole discussion will be led by the requirement that any concerns about treaty-violating state financing are dispelled. We will only act within our mandate.” Asmussen also stressed that he would like to see any ECB intervention initiated in tandem with use of the eurozone bailout funds, saying, “The error with Italy…must not be repeated,” seemingly referring to the Italian government's failure to take full advantage of the time bought by the ECB over the past year.

Meanwhile, Der Spiegel has a lengthy and interesting interview with Bundesbank President Jens Weidmann, the other German on the ECB’s Governing Council, in which he renews his opposition to any greater intervention by the ECB, warning, “We shouldn't underestimate the danger that central bank financing can become addictive like a drug,” adding that proposals for ECB bond purchases were "too close to state financing via the money press”.

Together, these two men represent Germany at the ECB, so for them to strike such different tones is rather surprising (although it has been hinted at previously). Asmussen remains much more positive and supportive of Draghi’s position, while Weidmann takes a more traditional German stance against any prospect of monetary financing of government debt (a position which has garnered significant support with the German public).

The real question though, is who has the support of German Chancellor Angela Merkel? That remains unclear, particularly with both having previously been close advisors to Merkel. The Spiegel article suggests that Merkel has become somewhat impatient with Weidmann's strict ideological stance, especially as it begins to hamper a potential path to crisis resolution (at least in her eyes). However, last week Handelsblatt suggested Merkel had in fact decided to side with Weidmann over Asmussen.

If this divide continues, the issue will likely come to a head leading to some tough decisions for all involved – in fact any decision to sanction greater intervention would make Weidmann’s position in particular quite difficult. Choosing who to support will be a difficult political decision for Merkel which goes beyond just figuring out how best to solve the crisis – she must weigh the public response at home and abroad, the market impact, her relationship with ECB President Mario Draghi and her support within her own party and the broader German coalition. Asmussen also has to tread a careful line as, despite being independent, he risks seeing his influence and support within Germany decline rapidly. Weidmann, whom many have suggested has already become isolated, risks a similar erosion of support, although abroad and within the ECB rather than Germany. If greater intervention comes to pass, as seems increasingly likely, the spectre of his predecessors Weber and Stark, both of whom resigned from the ECB Council in protest, will undoubtedly loom large.

As we have noted countless times before the role of the ECB cuts right to the heart of the German approach to the eurozone. Expect plenty more developments on this front in the near future.

The Eurozone’s new quick fix risks papering over much deeper cracks

In today's City AM, we argue:

With European politicians still nursing their holiday sunburns, speculation has already returned to the Eurozone crisis. Unsurprisingly, the focus is again on European Central Bank (ECB) intervention, not least because its president Mario Draghi’s commitment to “do whatever it takes” to save the euro may now require him to follow through.

The main plan being mooted is for the ECB to cap the difference in borrowing costs between stronger and weaker Eurozone nations. The logic is that growing yield spreads drive investor fear, do not represent the true strength of these economies, and threaten a self-fulfilling bond run. Germany is naturally wary.

The plan would place the ECB directly in the realm of fiscal policy and political decision-making – a dangerous and almost untenable position for an unelected, independent central bank. Bond spreads are ultimately the market’s judgement of the fiscal policy and domestic politics of each Eurozone country. Any failure or uncertainty in either area would see the level of ECB bond-buying directly influenced by national governments’ decisions. This is even more concerning given that, if borrowing costs have an effective cap, the incentive for governments to reform quickly and effectively would be severely reduced.

The oft-cited upside is that the ECB’s unlimited commitment would be enough to deter investors from challenging the ceiling on borrowing costs, meaning that the ECB may not be required to intervene much at all. But this impact may be overstated.

Take the peg between the Swiss franc and the euro, equipped with its own “unlimited” backstop from the Swiss National Bank (SNB). The SNB has had to defend the peg, causing it to accumulate reserves equal to 65 per cent of Swiss GDP. Clearly markets didn’t take the bank at its word. It’s not clear that the ECB would be any more successful, especially in the face of similar safe haven flows into northern Eurozone countries, and investors’ desire to offload risky assets at a decent price. Don’t forget that the ECB has also seen its own credibility dented over the past two years.

It’s been contended that current borrowing costs are irrational and therefore warrant ECB intervention. While yields may not accurately represent the economic fundamentals of each nation, they are a result of markets trying to price in the domestic and European political risk, as well as the structural flaws in the Eurozone. Using the ECB to try to “correct” these issues would damage the price determination mechanism in markets.

This leads us to another area of potential political controversy. The ECB would be taking a huge step towards risk and debt pooling by allowing an EU institution to redistribute problems around the Eurozone – since all Eurozone members stand behind the ECB. Such a huge decision, integral to the future of the Eurozone and Europe, should not be taken by an unelected apolitical institution.

The fact that such a decision can’t be made at the intergovernmental level is a sign that the Eurozone is not ready for such a move. Using the ECB to force the pace of integration may well backfire. It seems many have forgotten the problems caused by pushing ahead with an unfinished economic and monetary union, lacking clear political will, in the first place.

On top of all of this, such a move stands on incredibly shaky legal ground (thanks to its clearly defined statute, which stops it from financing sovereign states). It also fails to offer a solution. This is why intervention has little support in Germany.

The spreads in borrowing costs are a symptom of the crisis rather than a cause, although they have admittedly made things more difficult. However, artificially forcing them together will only paper over deeper problems. The best such a move can do is to buy time.

With the ECB already having bought Eurozone leaders two years, which were promptly wasted, we must ask whether this latest proposition is worthwhile.

There is, as of yet, no definitive answer. But the first move must be at the intergovernmental level. Until progress is made there, any move by the ECB would simply jeopardise its fundamental mandate, putting more money at risk and dragging the crisis on further, all without any clear end in sight. The ball is firmly in Eurozone leaders’ court and should stay there.

Super Mario lets the markets (and maybe not just them) down - for now

Italian Prime Minister Mario Monti and his Spanish counterpart Mariano Rajoy would have done well not to choke on their working lunch in Madrid while listening to ECB President Mario Draghi's press conference. In fact, in spite of last week's remarks that the ECB would do "whatever it takes" to save the euro (indeed, without overstepping its mandate), Draghi has today effectively said that the ECB is not going to do anything at all - at least for the moment.

As usual, some 45 minutes ahead of the start of Draghi's press conference, the decision on interest rates was made public and...nothing. They were all left unchanged. But interest rates were the side-show today, after all. Everyone was expecting an announcement on the purchases of eurozone debt on the secondary markets. And this is what Draghi told the press in his opening remarks,

[Eurozone] governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines. The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. 

 And then,

The [ECB's] Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.

Which, in practice, means:

• If Spain (or Italy) believe they need help to bring down their borrowing costs, they should tap the eurozone's bailout funds and accept the conditions attached to an EFSF/ESM bond-buying programme - rather than just waiting for the ECB to intervene;

• The ECB may consider buying bonds in coordination with the eurozone's rescue funds, if and when these have already been triggered following a request by a eurozone country. However, as Draghi stressed, the EFSF buying bonds is a "necessary", but not in itself a "sufficient" condition for the ECB to resume its purchases;

• On a more positive note, though, Draghi left open the question whether potential ECB bond purchases would, in future, be limited or unlimited. 

Not quite what Madrid and Rome were hoping for. Interestingly, Draghi also said that the very cautious outcomes of today's meeting - which the ECB President himself described as mere "guidance", and not "decisions" - had failed to obtain unanimity within the ECB's Governing Council, as one member (Bundesbank Chief Jens Weidmann anyone?) had expressed reservations.

Needless to say, the impact of Draghi's words on the markets has been immediate, and huge. Spain's stock markets index, Ibex, went down by almost 5% while the press conference was still under way, while Italy's FTSE Mib index has gone down by 3.4%.

But most importantly, the interest rate on Spain's ten-year bonds is now again worryingly close to 7% - a level widely seen as unsustainable. Monti and Rajoy are due to hold a joint press conference shortly, we will keep you up to date on our Twitter feed @OpenEurope.