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The ECB’s hair-splitting exercise on Greece

By Marc Chandler

The most important thing that ECB President Draghi has said in his prepared remarks was the reluctance to reschedule Greek bond holdings on grounds that would be tantamount to monetary financing.   

Really?  Buying the bonds in the first place did not count as monetary financing but extending the maturities, say for the ones that come due say in 2014, would?  What are the mental gymnastics behind that hair-splitting exercise? 

Press reports suggest that the IMF may want to pullout of further aid for Greece, but at the same time is pressing for official sector involvement (OSI) putting Greece’s debt on a more sustainable path.  It seems easy for it to advocate OSI for the other guy, but not for it.  The other guy in this case would seem to include the ECB, the national central banks, the EU and the EFSF.   So the IMF wants to defect but insists on the others cooperating.   

The Greece issue may continue to get kicked around through the Eurogroup meetings and the heads of state summit later this month.  November now seems to be the next crunch period of when Greece is projected to run out of funds.  Meanwhile, the French have come out more forcefully opposed to a Greek exit.  Something has to give and it is not clear yet what it will be.  

Separately, Draghi seemed to respond to critics who think that the conditionality that is required for the outright monetary transactions (OMT) is an obstacle to its use.  He places the conditionality at the center of the initiative.  It reduces moral hazard, he claims, and protects the ECB’s independence.  

Some European central bankers have gone further and argued that the conditionality is the “democratic element”, that the BBK President Weidmann argued was missing by OMT, which is a form of debt mutualization that is explicitly rejected by the democratically elected governments that signed the various treaties banning such a practice.  

Draghi suggests that the OMT program should not encourage nations to issue more short-term debt that would be covered by the scheme.  Yet that is precisely what is happening already, even with OMT being operationalized.  The average maturity in Spain and Italy is already declining.  Of course the large stock of debt means this will be a gradual process.  

As we noted, the ECB is one of the few major central banks that do not publish minutes to its meetings. He said this is under review.  It seems the ECB is worried about the political pressure that can be brought to bear on a detailed report of the discussions.  However, it is not like any central bank publishes verbatim of the discussions.  Moreover, it is not just about transparency.  The minutes themselves appear carefully edited to assist as a signaling tool.  

That interest rate cuts were not discussed at today’s ECB meeting is hardly surprising.  Not only has inflation ticked up and Draghi acknowledged it is higher than expected, but he warned that inflation is likely to remain above 2% through the reminder of this year.  The risks,  he again suggested were balanced, but the risks to growth were on the downside.   Given the economic conditions, the continued fiscal austerity and bank deleveraging, a 25 bp rate cut would likely be more symbolical than substantive.  

The euro was bid before the ECB meeting and continued to rise.  However, offers in front of $1.30 seemed to prove sufficient to stall the advance.  Short-term momentum indicators are stretched and, with the big event out of the way, look for a consolidative tone to emerge ahead of tomorrow’s US jobs data and the heads state meeting between France, Italy and Spain.   Although the market continues to trade French bonds as if it is a northern creditor country, Hollande, arguably more than Sarkozy, seems to recognize French interests lie with the southern debtors.  We expect investors to increasingly recognize this over time.  

Marc Chandler

About 

Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC and writes a blog called Marc to Market. Follow him on twitter.