3Q CENTRAL BANKING: For The ECB, Greece Changes Everything

 
   By Brian Blackstone 
 

        The third quarter was supposed to be uneventful for the European Central Bank. They had unveiled their big quantitative easing program in March that called for EUR60 billion in monthly bond purchases through September 2016.
        With monetary policy on autopilot they could sit back, watch the economy develop and berate European governments into doing more structural reforms.
        With Greece back in crisis, that benign scenario is out the window.
        Now, it is tough to gauge the ECB's response from one day to the next, let alone for an entire quarter. This is especially the case after Sunday's decisive "no" vote by Greeks against economic and fiscal reforms that had been demanded by their international creditors, leaving their future in the euro in doubt.
        The summer will prove particularly challenging for ECB President Mario Draghi. He has been emphatic that the euro is irreversible, saying last November: "The euro is - and has to be - irrevocable in all its member states, not just because the treaties say so, but because without this there cannot be a truly single money." But keeping Greece in the euro by financing its banks could force the ECB to bend its rules to the point where it loses credibility.
        The ECB will closely eye how financial markets gauge any fallout from Greece in coming weeks, and how the political back and forth in Brussels between Athens and other eurozone governments progresses. Some key benchmarks: bond yields; the euro and the spread between yields of safe-haven countries such as Germany and those of at-risk countries such as Italy and Spain.
        As of July 6, the fallout in financial markets doesn't seem too intense but that could change if Greece and its lenders fail to strike a deal to pay back Greece's arrears to the International Monetary Fund and redeem EUR3.5 billion in bonds held by the ECB on July 20.
        If Greece defaults on the ECB payment, the central bank would face a tough choice: cut the Greek banks off from emergency loans; or keep them afloat at the expense of its own credibility.
        If ECB officials see signs that contagion is undoing the benefits of their QE program, look for them to ramp up their government bond purchases or expand the pool of available securities to include other private assets. At a minimum, officials could send strong verbal assurances that stimulus measures will extend well beyond the fall of 2016.
        If yields hit crisis levels as they did in July 2012, then the ECB could activate another tool, an open-ended bond buying program--Outright Monetary Transactions--that has never been used. That program can be tailored to suit individual countries in need, but the drawback is that countries are first supposed to request assistance from Europe's bailout fund, which governments would probably be loath to do.
        That leaves QE as the likely first response to any market contagion emanating from Greece.
        Write to Brian Blackstone at brian.blackstone@wsj.com
        (END) Dow Jones Newswires

        July 08, 2015 05:59 ET (09:59 GMT)

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