In July, the President of the European Central Bank, Mario Draghi, promised to do “whatever it takes” to save the Euro. On 6th September he took action, announcing a new programme which could see the central bank spending billions of Euros to support troubled Eurozone countries. It was seen as the biggest step so far to protect the single currency, and sent a strong message to markets that the Euro is here to stay.
At its governing council meeting, the European Central Bank (ECB) agreed to launch a new, open-ended and potentially unlimited bond buying programme. Named Outright Monetary Transactions (OMTs), the Bank will be able to openly buy sovereign bonds in the secondary markets. The interest rates (‘bond yields’) struggling Eurozone countries have to pay on their bonds have become unsustainably high, but such ECB intervention should reduce the cost of borrowing for countries like Spain, Italy and Portugal.
Sig. Draghi explained that this would address the severe distortions in the government bond markets, which originate from investors’ “unfounded fears” about the survival of the single currency. It provides a “fully effective backstop to avoid destructive scenarios”.
“The Euro is irreversible,” he added.
The decisive move – which was opposed by Germany’s Bundesbank – was welcomed by most European leaders and the markets. It has been described by various analysts as a “game changer”.
Speaking to the Financial Times, Secretary-General of the Organisation for Economic Co-operation and Development (OECD) José Angel Gurría said: “This is your bazooka. This is the muscle and the fire power which is quite awesome because effectively, theoretically, it’s unlimited.”
What is different this time?
Sig. Draghi says that this initiative “will actually work”. There are a number of new elements compared to previous interventions.
Bond-buying will be restricted to short-term debt of up to three years.
The ECB will forego its status as senior creditor, so the Bank will take equal ranking with other creditors in the event of default. This should assure private investors that they will not be last in the queue to be paid back.
In an attempt to appease Germany, the bond buying will be “sterilised” to counter inflationary risk. The ECB will take an equivalent amount in deposits from banks to avoid flooding the Eurozone with new cash.
Collateral standards have been lowered, making it easier for banks to borrow capital.
There are very strict terms attached to receiving this assistance.
The ECB will only help countries which agree to implement strict policy conditions. They will have to request official help from the appropriate EU stability mechanism – in other words to apply for a direct bailout – and therefore put strong plans in place to get their finances back on track.
Sig. Draghi explained: “Governments will have to stick to their fiscal and economic reform plans before the ECB acts. They have to go to the European Financial Stability Facility (EFSF) because the ECB cannot replace governments and the action of other institution on the fiscal side.”
If the country breaches the conditions, the ECB could halt its interventions.
Portugal and Ireland are already receiving bailouts, but when it comes to Spain and Italy the ball is now in their court. If they apply for a bailout it will likely mean increasing austerity measures such as spending cuts and tax rises. They will not want to do this, but they do desperately need to reduce their borrowing costs.
Much of the response (though unsurprisingly not from Germany) was positive. Jim O’Neill, chairman of Goldman Sachs Asset Management, said that the ECB is “telling us the markets should not keep worrying about the risk of a Euro breakup and we will do things to enforce that reality.” Political leaders and central bankers have “fully signed up to some kind of medium-term United States of Europe”, he observed. Andrew Cox, G10 strategist at CitiFX in New York, said that the details “add to the credibility of the safety net taking shape in the Eurozone and should support demand for Eurozone assets”.
There are however concerns that this programme could impose more austerity on countries which really need to be looking to grow their economies, and that while lower borrowing costs would be good, the underlying causes still need to be addressed.
The ECB is fully aware that its action alone cannot fix the Eurozone. The bank made explicit political demands on Eurozone government leaders, saying that “policy-makers in the Euro area need to push ahead with great determination with fiscal consolidation, structural reforms to enhance competitiveness and European institution-building.” There needs to be more integration between countries, even if this means pooling sovereignty and surrendering national powers in fiscal and budgetary policy.
Nonetheless, the ECB’s bond buying programme does buy the troubled countries more time to right their fiscal imbalances and increase economic competiveness and productivity – and the importance of this should not be underestimated. There is still a way to go before the Euro crisis is behind us, but this is a positive step forward.
While British expatriates living in the Eurozone may be encouraged by the assertion that the Euro is here to stay, it is of limited value as it is only part of the story. The continuing macroeconomic background of financial pressures besetting Eurozone governments have led to them recognising the need to raise tax revenues.
This aspect is likely to continue and with capital and wealth taxes increasingly coming into focus, this puts property owning expatriates firmly in the firing line.
To explore how this impacts you and what options are available, you need to sit down with a firm which understands what local tax implications the Euro crisis has for British expatriates, and also considers the long arm of the UK tax office.
From an investment point of view, although markets reacted well to the news at the time, this does not mean the end of volatility in the short-term and it is important to have a well-diversified portfolio. You should seek professional advice on the most advantageous way to position your portfolio for current and future market conditions. Speak to a firm like Blevins Franks which specialises in providing personalised tax and investment advice to British expatriates living in Spain, France, Portugal, Cyprus and Malta, and can help you review and plan your wealth management in the current economic climate.
9th September 2012