A year after Mario Draghi vowed to do "whatever it takes" to save the euro, the European Central Bank president can claim to have staved off disaster, but he may have to back up his words with action before long.
Were eurozone turmoil to return, especially with Spain or Italy on the receiving end, Draghi and the ECB will have to prove that his promise, made on July 26 last year, has substance, something he and the ECB have not yet had to do.
This time last year, investors were piling up bets on the break-up of the 17-country currency bloc. Then, with 23 ad-libbed words, Draghi changed the course of the eurozone debt crisis.
"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough," he said on a warm summer day in London.
While that was enough to calm markets, it took another six weeks of frenzied backroom diplomacy and public sparring to flesh out a plan and announce that the ECB could buy unlimited amounts of bonds of countries that sign up for strict conditions through its Outright Monetary Transactions program.
A year later, the ECB has yet to use the plan.
To markets, the OMT is like a nuclear deterrent: the mere threat of its use is enough to keep an uneasy peace. Draghi has declared it a master stroke. "It's really very hard not to state that OMT has been probably the most successful monetary policy measure undertaken in recent time," he said last month.
"Draghi's speech was the game changer," said Michael Herzum at fund manager Union Investment. "It took the systemic risk out of the market by significantly reducing the likelihood of a break-up of the eurozone."
By the time of the speech, several eurozone countries had sunk into a predicament in which they could not survive their crushing debt load without help from their European partners.
First Greece, then Ireland and Portugal had to ask for full bailouts, and then Spain asked for help for its banking sector. A previous, more limited ECB bond-buy plan, the Securities Markets Programme, proved ineffective.
Not only had peripheral debt fallen out of favor, but the euro had dropped more than 15 percent against the U.S. dollar in the year before Draghi's speech. Now, the situation is reversing and it is up 9 percent in the last year.
Stock markets are also up across Europe, with the European blue chip benchmark index up almost 20 percent since. Italy and Spain have seen their 2-year bond yields fall from 5 and 6.4 percent, respectively, before the speech to under 2 percent, saving them immense amounts in interest payments.
The eurozone was also able to shake off the Cyprus bailout earlier this year, in which rich depositors had to take a big hit, with almost no contagion elsewhere.
RETURN TO GROWTH
On Wednesday, a business survey pointed to the eurozone returning to growth this month, the first time in 1-1/2 years, just in time for the anniversary of Draghi's speech.
But it is too early to sound the all-clear. Debt-ridden countries still need to regain competitiveness through unpopular budget cuts and reforms. And, as the crisis has shown, fickle markets can lose confidence in a country quickly.
With investors calmer, the ECB has moved the goal posts on what it would take for it to start buying bonds with the OMT plan, a sign that it would rather not activate the program.
"Now that financial markets have calmed and the economy is about to slowly recover, they really don't want to use this instrument," Danske Bank economist Frank Oland Hansen said.
The legal act for the program has not been published, and will not be before OMT is ready to be activated, Draghi said earlier this month, adding to the uncertainty of how to qualify.
"Draghi hopes that he will never have to fulfil his commitment," Union Investment's Herzum said. "Before his speech, it was never really clear if the ECB is the lender of last resort. Now, he is bound by his pledge."
But having to buy bonds on a massive scale could have legal ramifications. The German constitutional court in Karlsruhe is already examining whether the ECB overstepped its boundaries with OMT, and beginning unlimited purchases could force the court's hand.
"Then Karlsruhe cannot actually say anything but that there must be limits," said Lars Feld, an economics adviser to the German government. "The bond-buying program would not (then) be a bazooka anymore, just a machine gun."
Like nuclear weapons, the OMT's power comes from the threat it poses, not its use. To win smaller battles, the ECB has sought to expand its arsenal.
This month, it acted quickly to calm markets after the U.S. Federal Reserve's plans to slow its bond purchases. The ECB said it expected to keep interest rates at current or lower levels for an extended period of time.
However, the impact of this forward guidance has faded after policymakers made conflicting comments and fed the market view that the ECB was not pledging to keep rates low, but instead just that this was simply its baseline scenario.
Economists regard such statements as too weak to offer long-standing market calm.
"Forward guidance will be ineffective unless it is understood to involve a commitment to behave in a particular way in the future, differently than would have been understood in the absence of the announcement," Columbia University Professor Michael Woodford said.
Making mere forecasts instead of promises "undercuts the point of the attempted forward guidance and can even result in perverse effects," he added.
To get the desired results from forward guidance, the ECB might have to go further than with "whatever it takes," and actually put its money where its mouth is.
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