YESTERDAY THE European Central Bank unveiled its eagerly anticipated new bond-buying programme – to be known as the Outright Monetary Transactions.
It differs from the bond-buying mechanism established in May 2010 (the Securities Market Programme or SMP).
Conditionality: Countries whose bonds are bought by the ECB will have to apply formally. Once they have done so, they will have to commit to conditions and be subject to the same sort of oversight faced by countries already in receipt of bailout funds.
Collateral: Traditionally central banks accept only the highest- quality, triple-A securities as collateral from banks seeking to borrow. Typically, government bonds were favoured collateral.
But since so many sovereigns have been downgraded, banks have had fewer triple-A securities to lodge with the ECB.
Expediently, the bank has lowered its collateral standards.
It did so again yesterday. This will ease the risk of a tightening of the credit crunch, albeit at the price of exposing the ECB to greater credit risk.
Eligibility: Euro zone members seeking bailouts and those already in bailouts will be eligible to ask the ECB to buy their bonds.
Of the latter, only those “regaining bond market access” will be considered. This includes Ireland, but appears designed to prevent Greece from accessing the new programme.
Seniority: Under the SMP, the ECB put itself at the front of the creditor queue. When Greece restructured its debt earlier this year, the bank did not take a hit. That meant that private-sector creditors had to take more losses.
The “subordination” of private debt has the effect of reducing investor interest in holding weak government bonds – precisely the opposite effect intended by the ECB and euro authorities. It has conceded seniority in the new programme.
Although the OMT programme lived up to expectations, the ECB did not do a number of things that had been widely speculated on.
Capping bond yields: A surefire way of keeping sovereign's interest rates down would be for a central bank to declare that it would intervene in the market automatically if yields (interest rates) on bonds reached or exceeded a certain threshold.
The difficulties of deciding on a threshold and the risk that introducing one could end up inflating the ECB’s balance excessively are likely to have stayed the bank’s hand on introducing this measure.
Quantitative easing: A difference between the ECB's unorthodox actions to date and those of US and UK central banks is that the former has taken countervailing, or balancing, actions to prevent an increase in money supply, which can trigger inflation.
Central bankers describe countervailing actions as “sterilisation”.
Yesterday the ECB confirmed it would sterilise its OMT purchases of bonds, maintaining its avoidance – for now – of quantitative easing.
