Friday, 7 September 2012

OMT: Optiotic Methadone Therapy?

The ECB's headquarters. Source: ArcCan
OMT is the new acronym to enter the monetary almanac. It stands for Outright Monetary Transactions rather than methadone therapy as suggested in our title. What does this new policy have in common with methadone? Both are used to attempt to end the more destructive addictions of their patients.

The European Central Bank (ECB) will provide OMT to states that are trying to mend their ways. The treatment will comprise bond purchases that will reduce the patient's reliance on the undesirable elements of the private sector debt markets.

The dosage will be unlimited, but each fix will will be relatively short-lived (bonds bought will have a remaining maturity of less than five years). That means that patients will have to keep coming back regularly for more therapy until they are able to stand on their own feet again.

To receive the treatment, a patient will have to sign up to a treatment programme called the European Stability Mechanism (ESM). This is designed to make them strong enough to stand up to the aforementioned undesirable elements of the private sector debt markets.

The policy is a very positive one for Europe. It raises the possibility that speculators cannot drive the eurozone apart. It carries most of the requirements of a scheme which we outlined back in June during the euro area policy wish list. Stopping short of publishing the yield targets is a disappointment but not a showstopper. Markets will soon 'feel' the level at which intervention starts and will adjust their prices accordingly. If the 'unlimited' aspect is believed then it is doubtful whether many actual purchases will be required; nobody will want to sell a reasonably high yielding asset with little downside.

What will matter, however, is the progress countries make on structural reform. So far this has been limited as demonstrated by the World Economic Forum's Global Competitiveness Report, released yesterday. This revealed that very few of the uncompetitive countries of the Mediterranean region have made meaningful progress on reform.

As we wrote while discussing the options available to the ECB the lack of reform progress is unsurprising; labour reform in a recession amounts to political suicide. However, by addicting the patient to OMT, the central bank will be able to require those policies to be passed by whichever unfortunate party happens to be in government at any given time - a phrase we have used to describe this before has been "a victory for commonsense over democracy".

Guy Foster
Head of Portfolio Strategy

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