By Darren Williams
Political upheaval in Portugal has thrown the spotlight on the European Central Bank’s (ECB’s) bond-purchase programme, known as Outright Monetary Transactions (OMTs). Many are asking whether the ECB is ready to support the market if yields rise further. And if not, why not?
The treatment of Portugal has been a source of controversy ever since OMTs were unveiled last September. At the time, the ECB said the aim of OMTs was to safeguard “an appropriate monetary policy transmission and the singleness of the [ECB’s] monetary policy.” So why doesn’t Portugal qualify? After all, it’s complying with the strict policy conditions imposed by the European Union (EU) and International Monetary Fund [IMF] in exchange for bailout loans, while lending rates demonstrate quite clearly that the ECB’s monetary policy is not getting through to Portugal. Judged against the stated aims of OMTs, there seems to be a compelling case for intervention.
But right from the start, the ECB has made it hard for countries already in EU/IMF adjustment programmes (Portugal, Ireland and Greece) to qualify for OMTs. According to the original OMT press release, a country in financial difficulty can qualify for bond purchases by signing up for an EU/IMF programme, so long as the ECB is happy with the conditionality and thinks OMTs are warranted from a monetary-policy perspective. But for countries already in a programme, the press release states that OMTs will only be considered when they are “regaining market access”. At the time, this effectively barred Portugal from OMTs, because it was not then regaining market access.
Perhaps mindful that this might soon change, the ECB quickly tightened the criteria. At the October 2012 press conference, ECB President Mario Draghi said OMTs would not apply to countries already under a programme “until full market access, complete market access has been obtained.” And in March this year, Draghi defined this as being able to issue bonds “along the yield curve”, to “a fairly broad category of investors” and “in certain quantities”.
But this only highlighted the unfavourable treatment of Portugal and Ireland. While a country entering a new EU/IMF programme qualifies for OMTs when it has lost market access, existing programme countries only qualify when they are able to issue fairly freely in the primary market. In our view, this is rather like a doctor promising to treat sick patients, but only after they have made a full recovery.
So it would seem that the ECB has set rules that effectively bar Portugal from using OMTs for the purpose for which they were intended. And the suspicion must be that the Governing Council has done this in order to minimize the chances that it will have to buy any bonds—or, at least, put off that evil day for as long as possible.
But this is not just about Portugal. So far, the ECB’s offer to buy the bonds of compliant euro-area countries has kept a lid on the sovereign-debt crisis and prevented the euro from imploding. But the ECB’s treatment of Portugal reveals glaring inconsistencies in the OMT programme. Moreover, the central bank steadfastly refuses to provide greater clarity in this area—to the extent that Draghi has stopped answering these questions altogether.
Until now, investors have been surprisingly relaxed about the ECB’s ambiguity and the central bank will no doubt be hoping that this insouciance continues. But one day the market may call the ECB’s bluff. If so, our fear is that the ECB will be reluctant to back its brave words with the strong action required to prevent a big increase in peripheral euro-area bond yields.
Darren Williams is Senior European Economist at AllianceBernstein.
Disclaimer: The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.