During the financial crisis of 2008, U.S. Treasury Secretary Hank Paulson famously told Congress, “If you have a bazooka in your pocket and people know it, you probably won’t have to use it.” It seems European Central Bank President Mario Draghi took that statement to heart after information leaked that he would propose an unlimited bond buying program to help save the eurozone.
Under the plan, the ECB would be able to purchase and sterilize an unlimited amount of short-term government debt, preserving the money supply. Sterilizing the bond purchases means that the central bank would need to remove the equivalent amount of money else from the system to ensure that it has a neutral impact on supply.
According to Bloomberg:
At the moment, the ECB mops up the impact of its mothballed bond-purchase program by offering banks weekly term deposits that currently return 0.01 percent.
With the central bank’s deposit rate at zero and the euro- area banking system currently awash in about 800 billion euros ($1 trillion) of excess liquidity, a larger bond program may not present the ECB with a major obstacle.
While the ECB doesn’t expect to have to spend large sums of money on bonds, Draghi’s plan calls for no limits to be set, two of the officials said. The ECB also won’t have seniority on any bonds it buys, they said. No yield-spread targets or bands will be set publicly, they said. Two said targets won’t be set internally either and that interventions will be discretionary.
The market’s initial reaction to the prospects of an ECB bazooka has been positive, sparking a rally in European stocks and bonds, as well as the euro. However, how the market responds to Draghi’s comments tomorrow could signal the deeper impact of the plan. Draghi’s statements could have a larger impact on the Fed’s actions going forward as well.
