ECB FOLLOWS WORDS WITH MORE WORDS / THE WALL STREET JOURNAL ( VERY HIGHLY RECOMMENDED READING )

HEARD ON THE STREET

August 2, 2012, 1:35 p.m. ET


ECB Follows Words With More Words


By RICHARD BARLEY

The market verdict was clear: Mario Draghi had written a check he couldn't cash.




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The European Central Bank president promised last week to do "whatever it takes" to save the euro but the ECB didn't actually do anything at Thursday's meeting. Ten-year Spanish bond yields promptly rose back above 7%, and stock markets and the euro fell.

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 Spain will now come under great pressure to ask the euro-zone bailout funds for help with lowering its borrowing costs, something it has been desperate to resist. Above, the Frankfurt stock exchange on Thursday.

But the market reaction isn't entirely fair. Mr. Draghi's previous comments may have raised expectations too high, but he has provided the broad outlines of a plan for ECB intervention in government-bond markets. That certainly is a step forward.





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In particular, Mr. Draghi made two important points. First, that the ECB would intervene in markets only alongside the euro zone's bailout funds. This is crucial for the ECB because only the European Financial Stability Facility and its successor, the European Stability Mechanism, can ensure binding conditionality. A weakness of the ECB's previous bond-buying programs was that it relied on policy promises that politicians then failed to keep.




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Second, Mr. Draghi said investor concerns over ECB seniority would be addressed. The ECB's old Securities Markets Program has been effectively unusable since the central bank refused to take losses on its Greek bonds, leading to even bigger write-downs for private-sector bondholders. But how the ECB will structure any new program to avoid this problem is unclear.




.There still are plenty of other unanswered questions, too. Mr. Draghi said any intervention would be of a size "adequate to meet its objective." But what form will any future intervention take? How will the ECB define its objective? Is the ECB's commitment open-ended? Mr. Draghi hinted that any new program would focus on the shorter part of the yield curve, which would appear to have put a constraint on the scale of any ECB operation.





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Mr. Draghi said these details would be discussed in coming weeks. But a concern for investors is whether the ECB can deliver on these plans given the clear opposition of Germany's central bank, the Bundesbank. Mr. Draghi acknowledged that one country opposes bond-market interventions. The Bundesbank has only one vote out of 23 on the ECB's Governing Council so has no formal right of veto. But in practice, Mr. Draghi will be wary of defying his biggest shareholder.


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Spain will now come under great pressure to ask the euro-zone bailout funds for help with lowering its borrowing costs, something it has been desperate to resist. That, in turn, will reignite questions about the capacity of these funds. Worse, ratings firms may decide that asking for aid is enough to justify further downgrades, causing more problems.





Mr. Draghi's credibility is on the line. At the very least, the euro zone faces a long hot summer until his plans become clearer.



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