Germans tetchy over bonds plan

JUST hours after European Central Bank boss Mario Draghi played his trump card, the bank’s most powerful member refused to fall into line.

Germany’s Bundesbank issued a statement condemning the plan to buy bonds as ”tantamount to financing governments by printing banknotes”.

The comments underscore Germany’s long-held fears that it will be left carrying the financial burden of bailing out Europe’s cash-strapped governments.

It also highlighted how political complexities have continued to clash with market realities as European authorities seek to navigate the crisis that is pushing three years.

With Spain and his own Italy in his sights, Mr Draghi said the ECB was willing to buy as many one or three-year bonds as necessary, provided countries first agreed to fiscal and monitoring demands, including a role for the International Monetary Fund.

The buying of bonds on secondary markets will help ease money market fears about Europe’s troubled countries, with the aim of bringing down the crippling rate of interest some now face in attempting to raise funds from financial markets.

In a bid to rally the support of private bondholders, the ECB will accept the same default risk as them. This reverses its traditional position as a preferred creditor where it is at the front of the line in the event of a default.

The ECB will also ”sterilise” its purchases so as not to add to money supply and stoke inflation. This will see it offset these purchases in full by taking an equal amount of money out of circulation.

By putting its bond holdings on an equal footing with investors and requiring governments to commit to restoring fiscal order, the ECB is hoping investors will view any intervention as credible and join its buying, said James Nixon, chief European economist at Societe Generale.

The ECB can also terminate bond purchases if governments fail to fulfil their part of the bargain.

Details of the program immediately saw yields on Spanish and Italian long-term bonds fall overnight, even as both countries did not seek protection of the program.

The program – called Outright Monetary Transaction – also highlighted the power now converging around Mr Draghi as he seeks to steer the politically fractured region out of financial turmoil. Strategically, the program was announced just days out from a German constitutional court ruling on whether a €500 billion ($$A612 billion) long-term bailout program meets German laws.

Many expect next Tuesday’s ruling to fall in behind the European Stability Mechanism, although the court may impose some conditions, muting the impact of the fund.

Compared to the turmoil – particularly over the past 12 months – economists at National Australia Bank believe the region is now inching towards a solution.

”The sense of panic prevalent before August looks to have gone for now, but in the months ahead the ECB will doubtless have to actually intervene in markets in order to show that distortions in bond markets will not be tolerated,” NAB said in a note to clients.

Some, including Citigroup economists, believe the bond efforts could be too late and efforts should instead be focused on building financial firewalls.

Indeed, Citigroup has put the probability of a Greek exit from the eurozone as high as 90 per cent.

But Mr Draghi insisted several times during a press conference that the euro would not be allowed to fall apart.