• 12 Oct 2012

The European Central Bank's pledge to buy the bonds of troubled euro zone members

Mike Peacock
EMEA Economics Editor

The European Central Bank's pledge to buy the bonds of troubled euro zone members has flooded a wave of relief across the currency bloc but investors are now waiting for action to match the words. The problem is that until Spain seeks help from the new euro rescue fund to lower its borrowing costs, the ECB cannot intervene and for a number of reasons Madrid is vacillating.

Going cap in hand to its European partners would be a bitter blow to Spanish national pride and, because of that,  the government will want to wait until key regional elections are out of the way at the end of the month. Moreover, it’s not clear – given the mixed messages from Spanish ministers – whether they believe they really need a bailout. Since ECB chief Mario Draghi pledged to do whatever it takes to save the euro, Spanish bond yields have tumbled.

We also have it on good authority that Germany wants Madrid to hold off for now. Angela Merkel faces an increasingly fractious Bundestag and we think she wants to go back to it only one more time with one package covering Spain, Greece and maybe bailouts of the small Cypriot and Slovene economies.

But for Spain, the math will in the end win the day. It faces big debt refinancing bills over the rest of this year and next and a deepening recession means it will almost certainly miss its deficit-cutting targets, requiring even more borrowing.  On top of that, markets are likely soon to grow impatient to see the ECB put its money where its mouth is and actually buy some bonds. Without that, Spanish borrowing costs could soon be on the rise.

Because of Merkel’s position, Spain may have to wait until the Greek numbers are made to add up. It is clear that Athens cannot meet the debt targets spelled out as part of its second bailout. There is talk of giving it a further two years to make the necessary cuts and/or the ECB and euro zone governments taking a writedown on the Greek bonds they hold. What is increasingly apparent is that its euro zone and IMF lenders do not yet agree on the way forward. However, a path will be found, not least because that Merkel is increasingly convinced that Greece must stay in the euro zone – at least until German elections in a year’s time.

The inspectors from the EU/IMF/ECB troika are expected to deliver their report on Greece in time for the next meeting of euro zone finance ministers on Nov. 12. After that, things could start moving on a number of fronts.