Just like that
Mario Draghi is known for his ability to sway markets without spending a cent. The European Central Bank’s quantitative easing programme, expected to be unveiled on Jan. 22, presents its president with a rather different challenge: persuading investors to react positively to a 600 billion euro sovereign bond-buying programme which they have had plenty of time to anticipate. Still, Draghi may have some tricks up his sleeve.
The euro has fallen and stock and bond markets rallied even before any announcement. But there is high uncertainty about how the scheme will actually work. Investors don’t know if credit risks will be shared across the euro zone, or borne by individual national central banks. Nor do they know whether the purchases will be limited to investment grade bonds, which maturities will be eligible for purchases, or what limits there will be on such buying. Most importantly of all, they have no idea what limit the ECB will set on its purchases.
This gives Draghi some room to be bolder than investors are expecting. The ECB could announce a much bigger buying programme. Better still, it could copy the Bank of Japan, which has said it will buy whatever it takes to achieve its inflation target. If so, the euro could fall further and Draghi’s reputation would be burnished.
Even if this sort of carte blanche bond-buying fails to win support, Draghi has other options. Imposing as few restrictions as possible on bond-buying would help, as would getting the ECB to bear all or most of the credit risks. Investors will be less picky about this risk if they see the ECB is willing to overlook such considerations. The result could be a more rapid compression in the premium that investors demand to hold peripheral euro zone bonds rather than German debt.
Of course, there is also scope for the ECB to disappoint. Weekend Greek elections could prompt the central bank to announce only a general intention to buy government bonds. The ECB president would no doubt finesse such a setback, but investors would react badly to any sign of weaker resolve. Given the state of the euro zone economy, the better option would be for Draghi to over-deliver.