THE EUROPEAN Central Bank (ECB) is expected to escalate its response to the euro zone crisis this week, with an immediate focus on measures to shore up the region’s weakened banks.
Thursday’s ECB council meeting in Frankfurt is likely to agree steps aimed at preventing a severe credit squeeze that would drive the euro zone into recession, and at averting acute problems at individual banks.
The ECB meeting is a prelude to euro zone leaders’ summit meetings starting in Brussels on Thursday evening. By next weekend, agreement on steps towards a fiscal union could have paved the way for the ECB to provide more aggressive support for strained euro zone government bond markets.
However, the central bank will remain wary of escalating bond-purchase programmes until it feels politicians have come up with a fiscal plan of attack. If a legal means can be found, the ECB could demand an indemnity against losses on its bond purchases, which have already exceeded €200 billion. That could further encourage politicians to take action and ensure the bank’s independence.
“On Thursday, the ECB has to put the bandages in place to reduce the risk of a big accident before the euro zone fiscal plan is finally put in place,” said Erik Nielsen, chief economist at UniCredit. In contrast to its bond market intervention, the ECB sees help for the financial system as its clear responsibility, added Jacques Cailloux, European economist at Royal Bank of Scotland.
The ECB has become increasingly gloomy about euro zone prospects. Mario Draghi, ECB president, told the European parliament last week: “We have observed serious credit tightening . . . which, combined with a weakening in the business cycle, does not bode at all well for the months to come.”
At least some ECB council members fear the pace of contraction over the winter will be significantly worse than the “mild recession” predicted last month by Mr Draghi. The bank’s growth forecast for 2012 is likely to be revised down significantly.
As the euro enters a decisive week, markets remain on tenterhooks amid fears that failure to reach a deal will trigger a break-up of the single currency.
Sources close to German chancellor Angela Merkel say she is prepared, despite hostility from the German Bundesbank, to see the ECB step up buying of troubled states’ bonds as a short-term bridging measure until stricter budget controls take hold.
German finance minister Wolfgang Schäuble gave details of his proposal at the weekend for a sovereign debt redemption fund that would see EU states siphon off the chunk of their debt that exceeds 60 per cent of gross domestic product (GDP) and place it in a national fund, paying it off over a 20-year period.
The plan, which Mr Schäuble intends to present at this week’s crunch summit of EU leaders, has won qualified support from Dr Merkel, who is pushing for binding EU rules on budget discipline.
Despite short-term market optimism about a deal to tackle Europe’s sovereign debt crisis and underpin the survival of the single currency, the outcome is far from certain. Some bond managers are betting on a Greek and Portuguese exit from the single currency.
Kathleen Gaffney, who manages $80 billion in bonds for Loomis Sayles, told the Financial Timesshe believed the euro will survive the current crisis, but Greece and possibly Portugal will later leave the currency union in an orderly fashion. – 2011 The Financial Times Limited/ Additional reporting: Reuters
