ECB Ready to Start Buying Government Bonds

European Central Bank President Mario Draghi said the bank is ready to start buying government bonds as soon as the necessary conditions are fulfilled, putting the onus on Spain to decide whether it wants a bailout.

The ECB is ready to undertake Outright Monetary Transactions “once all the prerequisites are in place,” Draghi said today at a press conference in Ljubljana, Slovenia, after policy makers left the benchmark rate at a historic low of 0.75 percent. The plan has “helped to alleviate tensions over the past few weeks” and “now it's really in the hands of governments.”

A month after Draghi unveiled the unprecedented bond-purchase plan to lower yields on government debt, Spain, the country most likely to take up the offer, is still mulling whether it wants to accept the conditions attached. At the same time, the euro-area economy probably entered a recession in the third quarter as the sovereign debt crisis damped spending and investment.

“With the OMT, the ECB has tackled and exorcised fears of an imminent eurozone break-up,” said Carsten Brzeski, senior European economist at ING Group in Brussels. With governments now under pressure to act, “for the time being, the ECB can lean back, watch and twiddle thumbs.”

The euro extended gains as Draghi spoke, rising to $1.2992 for a 0.7 percent advance on the day. Separately, the Bank of England held its bond-purchase target at 375 billion pounds ($603 billion) today and kept its key rate at 0.5 percent.

Under Draghi's OMT plan, a country must make a formal request to Europe's bailout fund to buy its debt on the primary market before the ECB considers buying bonds on the secondary market. Spanish Finance Minister Luis de Guindos has said officials are still considering whether they need European Union aid.

While bond markets have rallied since Draghi pledged on July 26 to “do whatever it takes” to preserve the euro, Spanish bonds fell for a second day today as the nation sold 3.99 billion euros ($5.2 billion) of two-, three- and five-year securities. Spain sold three-year notes at an average yield of 3.956 percent, up from 3.845 percent at the previous sale on Sept. 20.

Monti Caution

The yield on Spain's 10-year government bond rose 3 basis points to 5.79. Three months ago, the yield was above 7 percent. The yield on Italy's 10-year security fell 1 basis point to 5.076 percent.

Italian Prime Minister Mario Monti cautioned last week that aid shouldn't hinge on more conditions than leaders already signed up to and the International Monetary Fund shouldn't need to police it.

Conditionality for a bailout “doesn't necessarily have to be punitive” Draghi said as he praised Spain for making “significant progress” in addressing its banking crisis. Still, “the ECB cannot replace the action of governments.”

On Greece, Draghi rejected the suggestion that the ECB would participate in any further restructuring of Greek government bonds. “We have said several times that any restructuring of our holdings would qualify as monetary financing,” he said.

While the ECB waits on Spain, the euro-area economy is deteriorating. Manufacturing contracted for a 14th straight month in September and consumer confidence also declined.

The ECB last month forecast a deeper economic contraction for 2012 than it did three months earlier, saying gross domestic product will drop 0.4 percent instead of 0.1 percent.

“Economic growth in the euro area is expected to remain weak, with ongoing tensions in some euro-area financial markets and high uncertainty still weighing on confidence and sentiment,” Draghi said.

Draghi also said that the ECB didn't discuss cutting rates today, even though inflation will drop below the ECB's 2 percent limit next year.

“Another rate cut seems even less likely given this rhetoric,” said Christian Schulz, an economist at Berenberg Bank in London. “The ECB does not expect inflation to revert back to the 2 percent target before 2013.”

A majority of economists surveyed before Draghi spoke forecast that the ECB will cut its benchmark rate in December.

Bloomberg News

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