Reports of end to the euro zone crisis are premature

The sheer size of the imbalances allowed to build up in the period following the launch of the euro means it will be several years before any commentator can declare an end to the crisis is in sight

MARIO DRAGHI, the European Central Bank’s president, revealed the monetary policymaker’s latest creative response to the rolling euro-zone crisis during the first week of September.

Investors greeted the central bank’s latest manoeuvre, known as Outright Monetary Transactions (OMT), enthusiastically, and pushed stock prices to within touching distance of 52-week highs in the days that followed.

The advance added to the robust double-digit percentage point gains already enjoyed since late July, when Draghi declared that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”.

The stock price reaction was understandable in light of the moves in other financial markets, which suggested the OMT programme will be sufficient “to remove tail risks from the euro area”.

The yield on under-pressure 10-year Spanish sovereign bonds, for example, dropped almost 200 basis points from the summer high of 7.4 per cent to well below the psychologically important 6 per cent level.

The yield on comparable Italian government debt securities declined from 6.6 per cent to below 5 per cent over the same period.

Meanwhile, the single currency appreciated by more than 8 per cent vis a vis the dollar, to the highest level in five months.

The programme has been described as a game-changer by some; others have gone so far as declaring that an end to the monetary union’s woes is imminent.

The idea that the latest liquidity operation is an important step is beyond dispute; the notion that the crisis is almost over is sheer nonsense.

The revelation that the ECB would be willing to engage in the unlimited purchase of troubled-periphery, short-maturity sovereign bonds in the secondary market under certain conditions, and would be prepared to continue the programme until its objectives are achieved, means the monetary authority is ready to accept de facto the role of lender of last resort to governments, even though this was not explicitly stated by the central bank.

In acting as lender of last resort to beleaguered governments in the euro zone, the ECB removes the ability of private investors to precipitate a sovereign default.

The bank’s commitment to purchase government debt securities in the secondary market should ensure that new issuance can take place in the primary market at acceptable yields to the sovereign borrower.

Further, the programme should ease liquidity pressures among the periphery’s ailing bank sectors, as the funds from secondary market purchases replace the funds lost to deposit flight.