After markets worldwide tumbled (especially Europe, down 6.4%) from July 20th through the 25th, the European Central Bank’s president Mario Draghi cried uncle with rhetoric aimed at stemming the decline; and it worked (at least temporarily).
Yesterday stocks rallied on word from Draghi that the Euro would not be allowed to fail. Vanguard’s Total World ETF (VT) jumped over two percent. Stocks are up again this morning as the Euro has recovered to a three week high versus the dollar.
Dow Jones’ correspondent Alen Mattich said the ECB’s mandate has been to control inflation (see video below). However, the problem is the periphery economies (Greece, Spain, Portugal, Italy) have been suffering from deflation. So Draghi is essentially saying we (ECB) have no mandate to buy bonds, but our primary mandate is to maintain 2% inflation (stable prices), Mattich said.
Mattich explained the ECB has tried everything else and they now need to drive down yields across the periphery countries. The ECB has rules and restrictions which don’t allow the monetizing of debt across the periphery; essentially preventing it from engaging in the Fed’s Quantitative Easing (QE) type of operations.
Mattich commented on the bond market in Spain where yields on two year bonds had risen to over 7%; which meant “Spanish companies and the government were facing 5% real yields which were crippling…with 2% inflation, 5% real yields are catastrophic for a government.”
There are restrictions on the ECB buying soveriegn bonds, but what Draghi seems to be saying is that our primary purpose is to maintain price stability, but we’re not having that because we’re about to suffer from deflation, according to Mattich. So we can ignore our other restrictions (against bond buying) to achieve our central goal of price stability. The German’s might not be happy about it, but their economy is doing rather well and they are tied into this project, Mattich concluded.