Although the market felt a little bit put off at the ECB’s last press conference, given Mr. Draghi’s “whatever it takes” rhetoric the week before, speculation has remained at fever pitch ever since. It appears that the ECB is debating implicit or explicit upper limits for bond yields. Little wonder that the short ends of the Italian/Spanish yield curves have rallied massively. At the same time Bundesbank president Weidmann has repeated his well-known resistance.

The fact that recent statements from ECB board members are still partly contradictory suggests that many details still have to be fleshed out and Mr. Draghi might again be short on detail at next week’s press conference. It seems that the ECB will not insist on the elevated seniority status, which proved to be counterproductive with SMP 1.0. What exactly conditionality with respect to an EFSF/ESM programme means appears to be highly contentious. While Jörg Asmussen would like to have even the IMF on board his French colleague on the ECB board, Benoit Coeure, sees a formal request for EFSF support as sufficient. A “whatever it takes” strategy implies the risk that it may ultimately violate Article 123 (no monetization of debt) – via its impact on the ECB’s balance sheet – and more generally erode the ECB’s credibility. Furthermore, the ECB could find itself trapped if a programme country fails to fulfill the conditions of its MoU. Will the ECB in such a case stop buying as conditions have not been met or will it justify further purchases since the market demands higher premia, because of increased – but intolerable – convertibility risk?

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Published with kind permission of Deutsche Bank Research.