The ECB announced early this morning (10 May) that the move, dubbed the 'nuclear option' by many economists, was justified because of government promises to meet strict budget targets and step up consolidation efforts.
The announcement was part of a decision reached by the European Union and the International Monetary Fund to pledge nearly $1 trillion in loans to defend the euro and the euro zone from speculators (EurActiv 10/05/10).
Boosting its firepower further, the ECB said it would also re-start dollar lending operations and bring back some of the emergency liquidity measures it had started to phase out.
"The European Central Bank decided on several measures to address the severe tensions in certain market segments which are hampering the monetary policy transmission mechanism and thereby the effective conduct of monetary policy oriented towards price stability in the medium term," it said in a statement.
Only last Thursday, after the central bank's monthly meeting, ECB President Jean-Claude Trichet said policymakers had not discussed buying government bonds.
The size of the purchases is yet to be determined, but the ECB said they would be offset by liquidity-absorbing operations so that the stance of monetary policy is unaffected.
Under the plan, agreed late on Sunday, the ECB will buy and sell both government and private bonds on the secondary market.
"This truly is overwhelming force, and should be more than sufficient to stabilise markets in the near term, prevent panic and contain the risk of contagion," Marco Annunziata from UniCredit Group in London said of the overall deal.
"Not only is the headline number stunning, but the ECB's decision to intervene in the secondary market should offset concerns about the time it will take to deploy the stabilisation funds," he added.
The fact that the bond purchases will be offset by liquidity absorbing operations means they will not have the same potential impact on inflation as straight purchases, such as those undertaken by the US Federal Reserve and the Bank of England.
International Monetary Fund chief Dominique Strauss-Kahn said market reaction to European policymakers "bold steps" was heartening.
"I think we have to wait a little more, but I think all this is rather encouraging," he told reporters on the sidelines of the BIS meeting.
(EurActiv with Reuters.)
