The European Central Bank's controversial plan to offer unlimited support to bond markets will not resolve the region's sovereign debt crisis, according to a report published by Moody's Investors Service Monday.
The plan, announced last week by ECB President Mario Draghi with the support of all but one of his Governing Council colleagues, effectively trades bond purchases (which hold down borrowing costs) for political commitments on austerity and budget discipline from the respective countries whose debt is targeted. Bundesbank President Jens Weidmann has consistently opposed the idea which he calls "tantamount to financing governments by printing banknotes."
"The ECB may hope that the announcement alone will sufficiently reassure investors and remove the need for substantial purchases, but the evolution of the crisis suggests this is unlikely and that the markets will test the ECB's resolve," wrote Moody's analysts Alastair Wilson and Colin Ellis in their weekly CreditOutlook review.
Market reaction has been definitively supportive of Draghi's plan to date, referred to by the ECB as "Outright Monetary Transactions", or OMTs. Spain's benchmark 10-year bond yields have tumbled more than 200 basis points since Draghi first alluded to it on 26 July and fell the most in more than 20 years last week alone. It's currently being quoted at around 5.58 percent on the electronic dealing platform Tradeweb.
However, Moody's notes that the strict conditionality of the OMT programme, which links purchases to participation in a full-scale EU/IMF bailout, may erode some of its early market impact.
"It is also not clear whether Spain or Italy intend to apply for such programmes, or for how long the amounts available under precautionary programmes facilities would sustain each country if they did," the report said.
Spain's Prime Minister, Mariano Rajoy, has said he has not yet decided on applying for state aid via the European Union's two bailout funds and Italy's Prime Minister, Mario Monti, through a spokeswoman speaking to Reuters, said Italy would not accept new conditions begin attached to the OMT beyond what had already been agreed by the European Council in June.
"Because an ECB intervention hinges on politically determined programmes, the bank's independence is brought a little bit into question," said Volker Kauder, parliamentary leader of the Christian Democrats, in an interview published by the Germany daily Bild. "The ECB has reached the border of what is permitted."
IMF President Christine Lagarde told reporters in Vladivostok over the weekend that it supports the ECB plan and that Spain and Italy have done enough to warrant the trust of their EU partners.
"What the central bank has announced last Thursday is a clear indication of the framework in which it would be an active player in restoring the situation in the euro zone," Lagarde said. "Our sense is that now the euro partners know exactly what they have to do. As far as the IMF is concerned, we shall certainly be ready to help and to assist in the design and monitoring of eventual programmes."
Moody's says the plan will likely continue to buy time from the markets and keep access open for borrowers such as Spain and Italy, but will unlikely address the overarching weaknesses that are hampering economic growth within each.
"To the extent that investors believe that euro area authorities will use the time bought to push through domestic fiscal and structural reforms and broader changes to the euro area fiscal and economic governance framework," Wilson and Ellis wrote. "OMTs will support continued access to debt markets by peripheral sovereigns and banks, a credit positive. But ultimate responsibility for crisis resolution still lies with euro area governments."
Italy's national statistics institute said today that the economy shrank a deeper than expected 0.8 percent in the three months ending in June, taking the year-on-year decline to 2.6 percent, the steepest since 2009 and extending the third recession in a decade to a second year.
Spain faces a €27.5bn bill in October as maturing debt comes due and will need to be refinanced, a task that could be made more difficult if it loses its investment grade debt rating. Moody's, which currently rates Spain just one notch above "junk" status at Baa3, is expected to conclude its review of the rating by the end of this month.