What could the ECB do to save the euro?

The attention of world markets will be firmly fixed on the European Central Bank on Thursday, as it announces its monthly policy decision reports The Telegraph.

The declaration last week by President Mario Draghi that he will do “whatever it takes” to save the euro whipped markets into a frenzy. Investors took it as a signal that the ECB was poised to announce dramatic intervention to stem the eurozone crisis before policymakers take a summer break.

With expectations so high however, anything short of major action is likely to disappoint markets and trigger fresh panic. Here is a look at some of the possible options open to the Bank.

Banking licence
The ECB could grant a banking licence for the region’s permanent bailout fund, the European Stability Mechanism. This would allow the ESM to borrow from the central bank and take on a “lender of last resort” role for those sovereigns in difficulty but essentially solvent, like Spain and Italy. It would be a hugely significant move and likely have the most dramatic impact. Italy’s Prime Minister Mario Monti said yesterday such a move “will in due course occur”, but strong opposition from German policymakers makes it unlikely today.

Bond purchases
The ECB might opt to expand its Securities Markets Programme, which allows the central bank to buy distressed government bonds. The Bank has in the past bought a total of around €210bn of bonds in Greece, Portugal and Ireland, and later Spain and Italy. Economists believe that any further purchases would have to be on a far bigger scale to make an impact on Spanish and Italian bonds markets and bring borrowing costs down. Rather than limiting the programme, they say, the ECB would have to make it unlimited and permanent. Germany has long-opposed the SMP, but it hasn’t stopped the Bank in the past.

However, there is a sense that the ECB will only be prepared to intervene in a specific sovereign bond market at this point if that sovereign has first appealed for aid from the region’s rescue fund. Spain has so far resisted such a move for fear of repercussions. This could prove a major stumbling block. Nonetheless, the ECB could always announce its willingness to act should countries satisfy that condition.

Quantitative easing
The ECB has so far refused to consider the idea of monetary stimulus through quantitative easing. Bond purchases made under the SMP have been sterilised, with those bought offset by sales of other bonds, meaning no net stimulus to the eurozone has occurred. QE on the other hand would involve buying bonds across the region with newly created money. Again, Germany is vehemently opposed to the idea. The Bank could potentially use some sort of model to determine how many bonds per eurozone member it would buy. For example buying according to the debt-to GDP ratio of member states.

A liquidity boost
Another round of the ECB’s long-term refinancing operation could be favoured by the Bank. The ECB has already provided €1 trillion of liquidity through the LTRO and prevented Europe’s money markets from completely seizing up at the turn of the year. It may decide to revisit this again, given the region’s banking crisis is far from over. Collateral agreements could be loosened to make it easier for banks to get access to the cash, which might then make its way into the wider economy.

Lower interest rates
The ECB might opt to further lower interest rates. It cut borrowing costs to a new record low of 0.75pc in July from 1pc, so it has scope to go lower. However, this would be considered a “fiddling around the edges” measure with limited impact.

Combination of measures
The ECB is not limited to one option and could choose a combination to maximise impact. The most likely would be to combine bond buying and further liquidity provision.