European politicians have to deliver soon: UBS

UBS economist Martin Lueck explains to CNBC-TV18 that statement made by Draghi of assuring that he would do everything in his mandate to rescue euro seems coordinated as it was backed up by statements issued by Merkel, Hollande and Monti.

Lueck also adds that at some stage the politicians have to make good their promises which will be possible only when the adequate mechanism has been established. Below is an edited transcript of the analysis on CNBC-TV18. Q: What can Draghi do? He has almost put his own credibility on the line. He would have had some reassurance from Berlin as was indicative from statements that came in on Sunday. So what are you expecting?
A: First of all I think this was coordinated. What Draghi said was followed-up by statements from Merkel and French president Hollande and then reinforced by Monti from Italy.
So, it looks very much like it was coordinated at the helm of European leadership. Secondly, Draghi can initiate the so-called Securities Markets Program (SMP) which was set up by the ECB in the spring of 2010 to purchase government paper from peripheral countries.
This program had been put on hold in February to be reactivated at a later stage. With regard to liquidity supply in the form of another LTRO, I think this would be of limited effect as there is not much collateral as for this kind of operation especially in those countries where liquidity would barely be needed. So my best guess is that the ECB would activate the SMP again. Q: How much can he do in terms of using SMP money? What can it bring the yields to? Will that suffice an SMP programme?
A: I do not think that the ECB is aiming at pressing yields a lot lower in the peripheral countries. They are probably just trying to keep them in an area where they are now or slightly lower. I do not think they would try to get to something that would be long-term and sustainable, in a range of 3-4%.
I think they would rather try to keep markets from pushing rates even higher and even if rates had to be increased, it would be at a level that is sustainable even in the longer term.
The ECB would also make it totally incredible for markets to reinvest in peripheral bonds in these countries at some stage. So, it would create. for instance, a lot more damage, in my view, if the ECB allows peripheral yields, especially in Spain and also in Italy, to some extent to go to levels higher than 7.5% as seen in Spanish yields in the past week.
So, I would rather think that they would try to keep the yields in these countries at a level  which allows them to get finance in the medium-term, and would still leave markets some room to breathe.
_PAGEBREAK_ Q: Over the weekend, there were reports of a meeting planned between Draghi and German central bank chief Jens Weidman. Do you think that is a sign that something big is on the cards?
A: I think Weidman is just following up on relatively well-known positions of the Bundes Bank. He wants to remind us that there is, with the change of position of the central bank, which is just walking away from protecting the value of the money in the sense of anti-inflationary policies, some disconnect with some long-term risk, it is a well-known position of the Bundus Bank.
I do not think that Weidman or the Bundus Bank want to stand in the way of non-conventional measures used by the ECB. I just see them in a position where they want to be the 'warners' who said that this was probably some action that needed to be taken in this context, but it is also connected to some long-term risk.
I do not think that they want to stand in the way and I think that another discussion between Draghi and Weidman can only be constructive. Let us remember that the ECB has always stressed that whatever action they will take in the future, in terms of nonconventional measures, must be in the limits of their mandate and this has got to do with a very complicated process.
If the ECB's mandate were to be change, it would mean a treaty-change at the EU level which is very complicated and would probably also provoke another reaction from the Bundes Bank, but this is not on the horizon anytime soon. So far we are only talking about ECB action within its own mandate and that is something that Weidman would actually comply with. Q: There were a lot of statements issued by Hollande, Merkel, the ECB and the Bundesbank. Do you think this gives an indication that they are trying to put a floor to Italian and Spanish yields and not let the market take advantage of taking Spanish yields to 7.5%? Do you think there is a floor to Spanish and Italian yields?
A: I think that's at least the coordinated action I was speaking about earlier and that is why they are making these statements and trying to reassure markets without actually doing anything of substance.
At some stage, politicians will need to deliver on these promises. For that, the mechanisms need to be in place. As you know, it will take at least until mid-September, until the ESM is in power and that is now a tricky period of time of another six weeks or so when markets will be in limbo without knowing what can actually happen because the mechanisms are not even there.
I think that at some stage further action will be taken by the ECB, possibly in connection with the ESM. But this remains to be seen and what also remains to be seen is where the levels of periphery yields will stand at that time.
For the time being, I think that the politicians including the ECB, are just trying to keep bond markets functioning and they have been successful with the kind of moral persuasion or treating market-sentiment correctly. But at some stage they will need to deliver and they will be able to do that once the ESM is in place, but probably not before.