Wednesday, August 8, 2012
European leaders must seize the day
August 8, 2012
The move from depression to catharsis can be rapid. Though we await the details, the European Central Bank has committed to buying as many sovereign bonds as necessary from the likes of Spain and Italy without such purchases being funded.
The ECB is now leading the way in reasserting the credibility of the euro and of eurozone policy makers. The ability of the ECB to print money being practically unlimited, the promise to print if needed provides credibility that bond yields, which move inversely to prices, will come down – at least at the short end where the potential purchases are being envisaged.
As a result Spanish two-year bond yields have narrowed by 300 basis points and the Italian equivalent by 200bp since July 24.
Even though deflation is currently more of a problem than inflation, printing money can get out of hand: the trick is to promise to print but not need to. For that, sufficient credibility is needed to entice private bond buyers.