ECB bazooka faces peripheral tests Even before Mario Draghi stood up to unveil the European Central Bank's grand plan to save the euro on Thursday, leaks of the key points had seen it dubbed "SMP 2.0" by none other than Goldman Sachs, his former employer. Comparing the bond-buying programme to the ECB's 2010 attempt to control the bond yields of troubled countries was an unpleasant reminder of just how unsuccessful that programme was. Mr Draghi is convinced the ECB he presides over has it right this time. Renewed bond buying will be unlimited, unlike last time. Help will be tied to reform and austerity conditions imposed from Brussels, with the International Monetary Fund asked to supervise errant countries too. Most importantly, the ECB says it will consider itself ranked equally with other creditors, so its buying will not weaken the credit quality of privately held bonds. IN Capital Markets "There are very many differences with the previous [programme], which lead us to think that it will actually work," Mr Draghi said. The markets took him at his word, with bond yields in Spain, Italy and the rest of the eurozone periphery plunging and shares soaring. Investors, in a word, were euphoric. They had two good reasons. The ECB is promising to take away the risk of a euro break-up, the biggest threat hanging over the world economy. Strip that away, and every risk asset is worth more. The icing on what already looked like a very tasty cake was the ECB's surprise decision to loosen its collateral requirements again, meaning it will accept junk-rated assets as security against loans and even some assets denominated in foreign currencies. Put simply, the central bank is ready to absorb a big chunk of Europe's credit and currency risk, making the remaining assets safer. "This is a very substantive throw of the dice," says Ewen Cameron-Watt, chief strategist at BlackRock, the world's biggest fund manager. It's perhaps not the last shot in the locker but it is a very big play by the ECB. Many are supportive of the move. But John Burbank, who runs the San Francisco-based hedge fund Passport Capital, says the plan amounts to little more than manipulating market prices. "Markets are going in the opposite direction of the world economy," he points out. If you're positioned fundamentally [betting on economic slowdown] you're positioned against these clowns. Yet, even supporters of the plan accept major challenges remain. The most immediate problem is that the ECB will not do anything until Spain agrees to the politically toxic imposition of conditions by Brussels and, probably, the IMF. The rapid fall in bond yields gives Spain more financial headroom - removing the urgent need for help. But the longer Madrid resists conditional aid, the more risk there is that investor fears return. Mariano Rajoy, Spain's Prime Minister, has to sell a deal domestically, which will need delicate negotiations over the terms. And any rescue conditions are sure to be harder to accept if the IMF, already a hate figure in Greece, are involved. "He certainly can't sell the men in black suits," Mr Cameron-Watt says. The question for the longer term is how the ECB deals with the risk of moral hazard, the danger that Spain or another beneficiary fritters away the savings from cheaper financing in order to please voters. "What's extraordinary is that the euro is rallying almost because the ultimate taboo of central banking is being violated, the pro­active financing of fiscal imbalances through the central bank balance sheet," says Louis Bacon, founder of hedge fund Moore Capital. Before this all other QE [quantitative easing] was to further monetary policy when the interest rate lever had been exhausted. Here it's financing a government deficit because the market won't. For him, the ECB's approach to moral hazard will be vital. Is the ECB going to be a fiscal inquisitor or enabler? Germany's Bundesbank is so fearful of moral hazard that Jens Weidmann, its president, was the only dissenter from the plan among ECB policy makers. Many investors dismiss German fears as inappropriate when the survival of the euro is at stake. But the interaction of politics and the plan create genuine reasons to worry. Governments everywhere have a tendency to be over-optimistic in their forecasts, and those in the eurozone even more so. If and when Spain or another country being helped by the ECB misses its Brussels/IMF targets, the ECB will face a hard choice. It could threaten to stop buying bonds in order to enforce further austerity to put the country back on the fiscal track, at the cost of a deeper recession. But that would risk domestic turmoil and the rise of populist, anti-reform parties, as in Greece, while the market would be sure to go into a deep funk. Or the ECB could accept that a country had tried its best, and keep buying bonds even though targets were missed. But that would risk a backlash from Germany and a crisis of confidence in the central bank. Navigating between these two political risks would be tricky for a central banker at the best of times. When the world economy is slowing, it will be even harder.