Will The ECB Bail Out The Eurozone? Draghi Gives It Straight

Includes: DRR, ERO, EU, EUO, FXE, ULE, URR
by: Axel Merk

A feisty new European Central Bank (ECB) president squared the circle: Unexpectedly lowering interest rates by 0.25% to 1.25% while promoting a hawkish message. Highlights from ECB President Mario Draghi’s press conference:

  • Risks to the economy are broadly balanced, suggesting the interest rate cut may not be part of a series of cuts. Having said that, Draghi may be less willing to signal upcoming interest rate cuts than his predecessor.

  • While welcoming a bolstering of eurozone bank balance sheets to achieve a tier one ratio of 9% by next summer, Draghi made it clear he did not want to see the goal achieved through “excessive de-leveraging”. This is a pragmatic Draghi, as de-leveraging may make the financial system safer, but could be detrimental to economic growth. Instead, he favors raising capital for financial institutions.

  • Importantly, Draghi called for fiscal consolidation and sustainable pension systems amongst eurozone governments. The latter is a clear reference to Italy to pass pension reform.

  • When asked whether the ECB should be lender of last resort to save the eurozone, he quipped that an unlimited commitment to buy sovereign bonds would by no means assure success of the eurozone. Specifically, he highlighted that the ECB’s sole mission is price stability, not being the lender of last resort to eurozone governments.

Draghi made it clear that sovereign governments must not count on external help, but show they have the capacity to reform. External help, such as ECB intervention in the markets, does not help to restore long-term confidence in the markets.

“That’s it” were his closing words. It’s really very simple: Get your act together, national governments, and you’ll be fine. If not, you’ll pay the price (higher rates on your sovereign securities).

At press conferences, Draghi’s predecessor Trichet appeared uncomfortable at times, even after years of experience. If Draghi’s first press conference is any indication, he has a razor sharp vision that he will be able to clearly articulate. Long-term, this should be helpful to the eurozone reform process; in the short-term, it may increase the pain on policy makers. Having said that, we know by now that policy makers throughout the world only appear to act when they feel a lot of pain.

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