This time last year, Europe’s financial crisis reached a deafening crescendo. Government bond yields in the periphery were spiralling out of control, the euro was plummeting and investors were once again questioning how long it would be before a member state leaves the monetary union.
Step forward European Central Bank (ECB) President Mario Draghi, who in July 2012 essentially drew a line in the sand with his speech in London: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The reaction was instantaneous.
The biggest impact of Draghi’s intervention was on the short-term borrowing rates for Italy and Spain. Just before Draghi’s intervention, Spain had seen the yield to maturity of its two year bonds reach 6.7% in the secondary market – unsustainable in the long-term. Since Draghi’s promise, the yield on equivalent bonds has slowly come down to below 2%. The Italian government also saw a dramatic improvement in its borrowing costs, falling by almost three-quarters or close to 300 basis points.
Although investors still demand a significant premium for holding Spanish and Italian debt compared to for example Germany, the sharp fall in borrowing costs has been key to the restoration of investors’ confidence in the ability of the ECB to manage the monetary system. This has not only reassured domestic savers and investors in the periphery that Euro membership was likely to continue, but it helped win back external investors, helping to reduce and eventually reverse the impact of capital flight on the domestic economies.
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