European Central Bank unveils bond-buying

FRANKFURT, Germany — European Central Bank president Mario Draghi on Thursday said the central bank is prepared to buy government bonds in unlimited quantities to eliminate harmful distortions in financial markets fueled by fears of a euro breakup, but he reiterated that participating countries must promise to abide by strict conditions.

The new program, dubbed Outright Monetary Transactions, or OMTs, “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at his monthly news confer- ence in Frankfurt.

The program will let the central bank buy government bonds with maturities of one to three years in unlimited quantities, though purchases will be “sterilized,” or offset by draining an equivalent amount of money from the financial system, to avoid a potential rise in the money supply.

The ECB won’t have seniority over other bondholders when it comes to OMT purchases, Draghi said, in a bid to alleviate worries among private bondholders that they would have to bear a larger part of the burden in the event of a future restructuring. The ECB didn’t participate in an earlier restructuring of Greek government debt.

Bond markets applauded the news, which was largely in line with earlier news reports on the likely outline of the program. Yields fell on Spanish debt.

But strategists said investors may be getting ahead of themselves.

By focusing on the short end of the market, the ECB action could lead to a sharp steepening of the yield curve in financially stressed eurozone countries that could aggravate efforts to boost credit flow from the core of the region, said Ed Lalanne, senior strategist at Macro Risk Advisors in New York.

Also, it remains unclear how the ECB can maintain “pari passu,” or an equal footing, with other euro-

zone creditors, he said. If the ECB were to take losses on holdings of bonds purchased under the OMT, it would raise questions about whether the central bank was effectively f i nancing government deficits — a practice prohibited by the ECB treaty.

Azad Zangana, European economist at Schroders in London, said the ECB has pulled out a big gun, but that its insistence on sterilizing bond purchases robs it of ammunition.

“The ECB’s insistence to sterilize the bond purchases means the ECB can only buy bonds as long as demand for euro T-bills remains,” Zangana said. That’s because the ECB absorbs the extra liquidity put into the financial system by its bond purchases by selling T-bills.

“If demand dries up, as it did (under the ECB’s previ- ous bond-buying program) at the start of the year, then the bond purchases would be halted,” Zangana said. “In that sense, Draghi may be overreaching when he said the ECB would ‘backstop’ the monetary union.”

Draghi also stressed the ECB would withdraw bond-buying support for countries that fail to abide by terms of the conditions attached to help.

Unlike the previous bond-buying program, known as the Securities Market Program, the ECB will publish a detailed monthly breakdown of the duration of bonds purchased and what nation they come from. Under the earlier program, the ECB only published the total amount of bonds bought.

Earlier Thursday, the ECB Governing Council left its key lending rate at a record low 0.75 percent and kept its overnight deposit rate at 0 percent.

A Dow Jones Newswires survey of analysts found a minority had expected a cut in the key lending rate, while other surveys found a split among experts.

The bond-buying program is the latest effort by the ECB to buy time for eurozone policymakers by easing fears that Spain, the eurozone’s fourth-largest economy, could find itself shut out of credit markets. Spain’s fall would leave Italy, the region’s No. 3 economy and the world’s third-largest bond market, in the cross hairs. Italy is seen as too big to bail out under the eurozone’s current rescue capacity.

Draghi in late July vowed that the ECB would do “whatever it takes” within its mandate to preserve the euro. The ECB chief indicated the bank was ready to eliminate the “convertibility” premium, or the extra yield demanded by investors to hold certain bonds out of fear the euro could break apart.