By Central Bank News
The European Central Bank (ECB) launched an ambitious and bold plan to lower the excessively-high interest rates that some of its members are paying on their debt, proving to financial markets that it has the confidence to do whatever it takes to protect the single currency.
The ECB, which held its benchmark refinancing rate steady at 0.75 percent, will buy an unlimited amount of one to three-year bonds on the secondary market but under strict conditions that member states have to live up. To limit the inflationary impact of the scheme, named Outright Monetary Transactions (OMTs), the ECB will sell an equivalent amount of securities.
The central bank for the 17-nation euro area also made it easier for banks to obtain funds from it by suspending a minimum credit rating threshold and allowing them to use bonds issued in other major currencies as collateral.
“We need to be in the position to safeguard the monetary policy transmission mechanism in all countries of the euro area,” ECB President Mario Draghi said in a statement, adding:
“We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area.”
Despite the ECB’s cut in interest rates since November, companies, banks and governments in some of the member states, such as Spain and Italy, have been paying more to borrow than companies in other states, such as Germany, erasing some of the benefits of a single currency.
Draghi vowed in July that “the ECB is ready to do whatever it takes to preserve the euro,” arguing that some of the high interest rate that some members states are paying is due to fears that they will leave the euro zone.
“OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro. Hence, under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area,” Draghi said today.
Draghi stressed that the ECB would only activate its bond purchasing scheme if a member state applies for aid from the euro zone’s rescue fund – the European Financial Stability Mechanism and its successor the European Stability Mechanism – which will also purchase bonds. The International Monetary Fund will assist in designing the specific belt-tightening program.
“The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions for our outright transactions to be conducted and to be effective,” he said.
Underscoring the battering the euro zone economy has taken from the debt crises, the ECB revised downwards its growth forecasts from June. It now expects the economy to shrink between 0.2 and 0.6 percent this year and in 2013 growth is forecast of between 1.4 percent and a contraction of 0.4 percent.
In the second quarter, the euro zone economy shrank by 0.20 percent from the first quarter for an annual contraction of 0.5 percent.
“The risks surrounding the economic outlook for the euro area are assessed to be on the downside. They relate, in particular, to the tensions in several euro area financial markets and their potential spillover to the euro area real economy,” he said.
The ECB slightly revised upwards its forecast for inflation, projecting a rate of 2.4-2.6 percent in 2012 and 1.3-2.5 percent in 2013. The inflation rate in July in the euro zone was steady from June at 2.4 percent. The ECB targets inflation of below but close to 2.0 percent over the medium term.
“Risks to the outlook for price developments continue to be broadly balanced over the medium term. Upside risks pertain to further increases in indirect taxes owing to the need for fiscal consolidation. The main downside risks relate to the impact of weaker than expected growth in the euro area, particularly resulting from a further intensification of financial market tensions, and its effects on the domestic components of inflation,” Draghi said.
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