Comment: Watch out for Draghi’s credibility imploding

By GEORGE KEREVAN
Published on 08/09/2012 00:00

THURSDAY’S meeting of the European Central Bank (ECB) seemed to deliver the goods, at least if you look at the benign reaction of the markets. European share prices rose yesterday while the yield on Spanish and Italian bonds went down.

ECB boss Mario Draghi not only slapped down a challenge from the head of the almighty German Bundesbank, Jens Weidmann, who has lost credibility after backing down on a resignation threat. Draghi also delivered more than many were expecting.

The ECB now stands ready to buy unlimited amounts of short-dated bonds in the secondary market to force down yields, “Outright Monetary Transactions”, in ECB-speak. To qualify for ECB intervention, euro members must (a) request a bail-out, and (b) fulfil strict policy conditions imposed by both the eurozone and (this is crucial) the IMF.

But wait a minute. Neither Spain nor Italy – the two eurozone members in the firing line – has actually requested a bail-out. Neither seems anxious to meet the stringent social and budget reforms the IMF would be likely to impose. Unless they do, the markets are bound to test the willpower of both governments, and of Draghi, by sending yields sky high the next time anyone needs to borrow big money. Which is the second half of October in Spain’s case.

Mariano Rajoy, Spain’s prime minister, while a budget hawk, seems to have drawn a line at slashing his countrymen’s generous pension entitlements – something the IMF is certain to demand. Mindful of Spanish pride, Rajoy is also reluctant to accept the prospect of those humiliating monitoring visits every quarter by stern-faced inspectors from the ECB, EU and IMF.

Rajoy was in Berlin on Thursday to be told by Germany’s Angel Merkel (who has gone out on a limb to back the ECB over the Bundesbank) that Spain has to toe the line. But Rajoy is a tough negotiator and keeps insisting he won’t apply for a bail-out till after the eurozone and IMF tell what their terms might be.

This game of chicken could go on till the EU summit on 18 October, which has been primed by the Germans and French to approve a Spanish bail-out. If Rajoy declines to play ball – he has to fight tough regional elections on 21 October – then expect the markets to punish him during the final days of October.

Even if he does seek a bail-out, the game’s not over. The small print of Thursday’s announcement says the ECB must halt bond purchases if a country fails to respect the bail-out conditions. That is a political nuclear bomb waiting to go off. If the ECB ends market intervention, yields on a bail-out country’s bonds will soar and lead to national bankruptcy. If the ECB prevaricates, not only will Draghi’s credibility implode, the markets will short the affected bonds anyway. You’ve been warned.

North Sea move more cosmetic than effective

Chancellor George Osborne was in Scotland this week so what were the chances of some juicy economic announcement to steal the headlines from Alex Salmond? You’ve guessed it: there’s to be a cut in taxes paid on production from mature North Sea oil fields.

Of course, this merely gives back some of what Osborne took away in his 2011 Budget by suddenly increasing the supplementary charge on corporation tax (i.e. windfall levy) on those fields by some £2 billion per annum. At the time everyone knew this move – invented to pay for a headline-grabbing cut in petrol duty – would be counter-productive.

The thing with mature fields is that they need a lot of investment in expensive new kit to keep squeezing out the last of the oil and gas. No wonder, then, that Osborne’s 2011 tax wheeze saw output plummet by 18 per cent, and Treasury oil receipts fall by £2.3bn.

Nevertheless, Osborne’s latest U-turn is welcome and the share prices of the gaggle of independents now battling bravely to extract oil and gas from the older North Sea fields were duly rewarded.

However, I notice that only in the very last sentence of the long Treasury press release announcing the change do we learn what this move will cost the Chancellor – a mere £100 million per annum. Which suggests the new allowances may be more cosmetic than effective.