The President of the European Central bank, Mario Draghi, told investors last week in London that the ECB would do everything possible, within its mandate, to support the Euro and the Eurozone and that it had the means to do so. Today, the ECB announced that, as speculated by the markets, it would purchase bonds of Italy and Spain, in order to reduce financing costs. Yet, the markets were disappointed.
There are three reasons why this disappointment was almost predictable.
1. The ECB's balance sheet cannot be extended ad infinitum. It represents 36 % of Europe's GDP, the largest percentage of the industrial world. After a 50 % ($ 1.3 billion) increase to lend to European banks at 1% for 3 years, this balance sheet seems close to its limits. The ECB balance sheet is the double of the Federal Reserve's.
2. The ECB did not quantify its program.. Its objective to reduce the cost of financing requires the means to influence the price of more than $ 3 trillion of existing bonds issued by Italy and Spain. This is a daunting task that requires substantial ammunition. Where will they come from?
3.The ECB cannot act immediately. Its governance requires some committee meetings and approvals. Nothing should be expected before September.
To a journalist asking him whether he regretted having raised expectations last week, Mario Draghi responded that the ECB was not acting "with psychoanalysis but with economic analysis". Well, that might precisely be the problem of Europe. Populated with economists and lawyers who have limited knowledge and experience of market psychology, the European leadership is talking to itself, rejoicing at each of the last 20 summits that the measures they took meant the end of the crisis.
The European Financial Stability Fund has a limit of 440 billion euros of which less than 10% has actually been disbursed in two years. The last announcement in May of a $ 120 billion banking facility for Spain has not been disbursed. The European Stability Mechanism has not yet been set up.
It is the distance between the words and the actions that explains the abysmal level of confidence deserved by European leaders in the eyes of the market and investors.
Europe needs to act and, preferably, communicate when it is capable of implementing its actions. Anything else meets with skepticism. It is sad that Mario Draghi did not understand that it is the ECB credibility that is the loser today, and with it the expectations that he contributed to raise in the name of Europe. As far as Italy and Spain are concerned, their yields continued to raise.