The European debt crisis, writ small, will be contained in this week’s European Central Bank policy meeting.
ECB president Mario Draghi will be navigating the familiar terrain of German reluctance to bail out struggling members of the euro zone as he lays out the broad parameters of a new bond-buying program that could help countries struggling to stimulate their economies amid high borrowing costs.
The key will be to get the German central bank on side. The Bundesbank, which wields enormous clout among other central banks, is of the position that the bond-buying plan runs too close to an ECB-financed bailout program, something European treaties forbid.
“Germany wants to make sure there’s still pressure on governments to continue with their reforms [once the ECB purchases bonds],” said Benjamin Reitzes, a senior economist at BMO Nesbitt Burns. Otherwise, the program does little to push countries out of their current stressed positions.
In early August, Mr. Draghi announced he was considering a program to buy bonds from countries such as Spain and Italy where yields have been driven up by investors who fear default.
An inability to borrow money at an affordable cost, coupled with a requirement to sell new bonds to repay the old ones coming due, is essentially what forced Greece, Ireland and Portugal to take bailout loans in the past.
Higher yields affect the cost of borrowing for consumers and companies because banks base their interest rates on how cheaply they can obtain money from their country’s central bank. By driving bond yields down, the ECB hopes to stimulate borrowing and achieve its inflation target of 2 per cent.
For the ECB to purchase a country’s bonds, the country would first have to ask for help from the euro zone’s bailout fund, but that is about all that is known about the new bond-buying program at this point.
Mr. Draghi is expected to announce the size and duration of the program at the meeting Thursday, said James Ashley, a senior U.K.-based economist at Royal Bank of Canada. But he said Mr. Draghi is unlikely to go so far as name the exact yield the ECB will target with its purchases.
Mr. Draghi will have to craft his message carefully. Investors are expecting to learn important details on the bond-buying program from Thursday’s meeting, and financial market reaction will be “strong” and “adverse” if they don’t get it, Mr. Ashley said.