As all eyes turn to Italy and whether or not Silvio Berlusconi will step down in order that a technocratic government (headed by economics professor and former European Commissioner Mario Monti?) take over to quell market concerns, there is an interesting technical discussion underway about how far the ECB can go in its controversial buying up of the government bonds of troubled Eurozone member states. A matter not unrelated to events in Italy.
The FT’s Alphaville notes that the real practical limitation on the ECB’s intervention lies in its policy of sterilization. So far, the ECB’s interventions have been sterilized, meaning that its buying up of bonds issued by embattled Eurozone members has not led to an expansion in the money supply. When that happens, given the ECB’s fervent attachment to its price stability mandate, interventions will stop.
Alphaville cites a report by Rabobank which has tried to put some figures on where this limit to the ECB’s actions may lie. In order to understand the figures, we need to understand how the ECB sterilizes its interventions. Very simply, the ECB arrangement is that in exchange for its purchase of government bonds, European banks are meant to place an equivalent amount of cash at the ECB. The ECB every week, in line with its bond purchases, issues banks with seven day deposits. The money banks leave with the ECB in the form of these deposits is equal to what is introduced into the Eurozone money supply by the ECB’s bond purchases, leaving the net effect equal to zero.
With this arrangement, the ECB’s room for manouevre depends on the willingness of European banks to place their cash in these ECB deposits. According to the Rabobank report, this is not a problem at the moment given how much banks have borrowed from the ECB. The attractive rates offered by the ECB mean that banks have been happy to place what they have borrowed back at the ECB. But the actual situation, with European banks having so far (at the end of October) borrowed a total of 587 billion Euros from the ECB, is far from normal. For Rabobank, pre-crisis levels of borrowing by banks are around 450-500 billion Euros. With 200 billion Euros in capital requirements, that leaves the ECB with a maximum of 300 billion Euros for sterilization. So far, the cost to the ECB of its bond market interventions is 184 billion Euros. This leaves 116 billion Euros left for future sterilization purposes. Assuming the ECB will buy up bonds at a rate of 11 billion Euros a week, this means sterilization will have to stop by early 2012.
It may seem like a purely technical matter but the end of sterilized interventions would signal – for the ECB – a fundamental shift in its mandate. Some think it would rather let bond markets collapse than be pushed into making unsterilized intervention. Others assume that a behind-the-scenes evolution in the ECB’s role will be sanctioned by national leaders, themselves meeting to discuss the issue in their shadowy Eurogroup and Francfort group formations. If the ECB is indeed to be transformed into a lender of last resort – a move The Current Moment has said is a bad one given the absence of public support for more federalism in Europe – it should occur as part of a conscious and intended political choice and not as a technical detail of interest only to the financial pages of the broadsheet press.