5 Reasons Why Draghi Could Disappoint



The upcoming rate decision in the euro-zone holds very high hopes for a big bang (even full QE) that will change the course of the debt crisis, after ECB president Draghi and European leaders said they will do everything to save the euro.

However, there are 5 reasons to doubt that Draghi will indeed deliver on the closely watched decision on Thursday. Here are the reasons to be wary of the decision that will rock markets.

Among the various options that Draghi has in store, the biggest wish is for direct bond buying of Spanish and Italian debt by the SMP. The SMP has been idle for 20 consecutive weeks.

  1. Getting Bundesbank support:  The head of the German central bank Jens Weidmann has expressed his opposition to interventionist moves many times. He is perhaps less outspoken than his predecessor Axel Weber, but his views are still in line with the conservative approach of the Bundesbank. Draghi and Weidmann’s meeting before the ECB meeting will probably be a tough one. Weidmann is backed by another German member, Assmussen and by members of other countries from the north of Europe. While Draghi might have a majority in the council, he needs German support.
  2. Denial from German finance minister: Wolfgang Schäuble denied that the EFSF bailout fund will begin buying Spanish bonds. His ministry also said there are no talks about granting the ESM a banking license – thus enabling it to borrow from the ECB and buy bonds.
  3. Banking license issues: Even if Draghi ignores the German rejection for granting the ESM a banking license and opts for this move, it will likely get a negative reaction in the markets. Such a move requires treaty changes. The current ESM approval still awaits a ruling from the German constitutional court on September 12th. Spain and Italy’s bond yields cannot wait too long.
  4. LTRO failure: Draghi already made a bold move by launching two big Long Term Refinancing Operations, that amounted to a trillion euros. The scheme, to lend cheap money to banks in order to lower the bond yields seemed very successful at first by the markets and by Draghi himself, that commented on the success more than once. However, it backfired as the economic situation worsened and banks found themselves with big losses. Now Spanish banks need help from the government, which needs help from the banks. Draghi may be cautious in launching another bold move.
  5. Mandate issues: The Lisbon  Treaty in article 127 (clause 5) enables the ECB to act in order to get financial stability. A move of buying bonds also helps in the “transmission of monetary policy”. It was already used in the past. Nevertheless, another article disallows the funding of governments. Buying bonds en masse could be seen as monetizing debt. Will Draghi just do it and let the lawyers argue about the different clauses later on? Or will he hide behind the limitations? It’s important to note that Draghi said he will do everything “within the mandate”.
Another reason for disappointment comes from the expectations themselves: Draghi’s words about doing everything were echoed again and again by leaders. The euro and the markets are close to a complete standstill, awaiting the move. Expectations also overshadow the usually closely watched US rate decision.
Even if Draghi delivers various rate cuts, looser collateral rules and many other options altogether, without a direct move to lower Spain and Italy’s borrowing costs, markets will be very disappointed.

See all the options in the ECB Preview.




About

Yohay Elam – Founder, Writer and Editor

I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me.

Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.

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