As Marc Chandler pointed out this morning, the ECB may not live up to market expectations for unsterilized purchases of peripheral bonds (UPDATE 920 ET: It has now been confirmed that the ECB will not make unsterilized purchases of euro zone sovereign debt). The rumour had been for a purchase of up to 2 trillion euros in bonds, a massive move away from the ECB’s relatively hawkish stance. This is as close to the "unlimited liquidity" option I outlined earlier in the week. However, this type of draconian solution will only be taken as a last resort – and only if contagion produces large effects on the larger economies like Spain and Italy.
Nevertheless, given the debt burdens in the periphery, some combination of monetisation and default is the most likely eventual scenario for Europe. Ireland, for example, cannot grow nominal GDP at or above the 5.8% interest rate on offer under the bailout terms. Unless the country sheds its bank debt guarantee as I recommend, default is likely. Therefore, the ECB will have to step in or Europe will risk a meltdown and dissolution.
Market participants are already making their bets. Below John Brynjolfsson tells Bloomberg why he thinks the ECB will monetise the problem. His firm is selling core Europe and buying the periphery and betting on convergence.
(video embedded below)