ECB Plans 'Unlimited' Bond Purchases But Stops Short of Quantitative Easing

The European Central Bank will announce tomorrow that it plans to buy and "unlimited" amount of bonds in the market that have been issued by trouble EU members in order to lower yields and prevent any further spiralling of the region's two-year old debt crisis.

Bloomberg news, citing two unnamed sources briefed on the plan, reports that ECB President Mario Draghi's plan will target bonds which will mature in three years or less and that all of the Bank's purchases will be "sterilized" in order to prevent the impression that it's "printing money". Sterilizing bond purchases means the Bank will sell into the capital market - normally short-dated treasury bills - an equal amount of the securities it takes out, creating a "net neutral" effect on the region's money supply. Traditional quantitative easing is not sterilized and central bank purchases are specifically intended to increase money supply.

The ECB meets Thursday in Frankfurt and is widely expected to reduce its key lending rate by 25 basis points to 0.75 percent in an effort to ignite growth in the region's stagnating economies. However, investors are also looking for further details of Draghi's plan - first referenced during an investment conference in London on 26 July and then fleshed out during a press briefing after the Bank's last interest rate decision in August.

"We are unbiased observers, we think the euro is irreversible," said Draghi during the Global Investment Conference held in London and opened by Prime Minister David Cameron. "And it's not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible. But there is another message I want to tell you: Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."

Draghi's intentions to preserve the single currency, and his allusion to short-term bond market purchases to ease the spiral or rising yields, has led to a significant rally in European stocks and peripheral bond yields. The broadest measure of European share price performance, the FTSE Eurofirst 300, has risen 6.2 percent since Draghi's July speech, while 2-year government bond yields for Italy and Spain - the most likely targets of the ECB's purchases - have fallen 256 basis points and 378 basis points respectively.

"The ECB will have to deliver some details, but it must be reasonably happy about how markets have behaved in the past month," wrote Barclays' analysts in a research note published Wednesday. "In our view, the most likely outcome of the meeting is that the ECB will implicitly or explicitly agree to cap short-end peripheral yields, and probably at a lower level than currently. As importantly, the ECB needs to be united and committed to whatever it agrees: this will be key in its acting as an efficient backstop."

Bloomberg news reports that no explicit yield "cap" will be made public by the ECB under the new plan, which it says may be called "Monetary Outright Transactions".

The news has also impacted bond sales in Germany, where a planned €5bn auction of benchmark 10-year bunds raised only €3.61bn at the Government's preferred yield of 1.42 percent. Traders say the so-called "failed" auction could be a sign that investors prefer the higher yielding bonds of indebted Eurozone nations such as Spain and Italy if they know the ECB will support prices with an unlimited chequebook.

"We are open to the idea that investors might have total conviction in the permanence of ECB bond buying programme which then generates a virtuous circle in which confidence that low yields are here to stay leads the market to revise its expectation of debt sustainability, which then becomes a self-fulfilling equilibrium," wrote RBS senior economist Richard Barwell. "However, we also recognise that at the current juncture many if not most investors harbour some reservations about the ECB's commitment to the programme."

The ECB rate decision is slated for 1245 BST Thursday with the press briefing scheduled for 1330 BST.