European Central Bank governor Mario Draghi rolled out emergency measures for the region’s troubled banks but stopped short of backstopping governments mired in debt, making it clear that political leaders are responsible for the cleanup of their own fiscal mess.
Despite widespread calls for the ECB to use its power to bring much-needed stability to Europe’s simmering debt crisis, the central bank said it wouldn’t commit to large-scale sovereign bond purchases nor channel money into the International Monetary Fund’s rescue coffers. The ECB’s stance disappointed investors, who sent European and North American stocks sharply lower.
Investors had regained confidence in recent days leading up to the EU leaders’ summit now under way, bidding up stocks and European government bonds amid hopes the ECB would pull out a “big bazooka” to provide support for governments hit by soaring financing costs.
Germany, however, has consistently resisted sanctioning a radical boost to the ECB’s firefighting role as the debt crisis deepens. Germany enjoys the strongest fiscal position among the major European nations and fears any centralized support for nations grappling with major debt burdens could compromise its own finances. The country is opposed to a plan circulating at the EU summit to issue common euro zone debt, according to a report.
The conclusions seen by Reuters earlier said the permanent European Stability Mechanism rescue fund would get a banking licence and run alongside the European Financial Stability Facility, bolstering its ability to tackle the euro zone debt crisis.
Italian stocks dropped more than 4 per cent Thursday, leading Europe’s declines, while the euro fell 0.7 per cent against the dollar. Italian bond yields, which had fallen below 6 per cent, soared back above 6.5 per cent, reflecting the sense that ECB support for Italian bonds will be, at best, sporadic.
Mr. Draghi did, however, unveil a battery of unprecedented steps to help Europe’s ailing banks, which are having trouble securing interbank loans and are shedding assets, intensifying the economic slowdown. The ECB said it will accept a broader range of securities in exchange for emergency loans, and took other measures to free up capital available to banks.
The ECB also dropped interest rates by 0.25 per cent, taking them to an historic low of 1 per cent. The cut marks Mr. Draghi’s second since he replaced Jean-Claude Trichet, who had raised rates twice this year on the misguided expectation of strong, inflationary growth, at the end of October.
“All in all, the ECB delivered all it could without crossing the line of Germanic rules of central banking,” said ING Financial Markets economist Carsten Brzeski. “For the time being, the ECB does everything to be the lender of last resort for the economy and the financial sector but not for governments.”
Other economists similarly said the ECB’s moves were welcome but fell short of what is needed to snuff out the two-year-old debt crisis. “It would be grossly unfair to characterize the ECB’s decisions today as being Scrooge-like, but the [ECB]governing council certainly didn’t provide the Christmas bonanza many were [(unrealistically) hoping for,” said Jens Larsen, an economist at Royal Bank of Canada’s investment arm in London.
Even though the ECB is unwilling at this stage to become the euro zone’s lender of last resort, it appeared that the IMF – the co-sponsor of the bailout packages of Greece, Ireland and Portugal and monitor of Italy’s austerity program – might itself take on a greater firefighting roll. On Thursday, euro zone officials said the 27-country European Union (17 of which are euro zone members) is nearing a deal to lend about €150-billion ($205-billion) to the IMF.
The funds would come from loans from the euro zone’s central banks to the IMF; another €50-billion might come from EU countries outside of the euro zone. While the amount appears large, it is insignificant compared, say, with the €1.9-trillion of national debt carried by Italy, a country considered too big to bail out if were to find itself shut out of bond markets.
The ECB is opening the credit spigots to the banks, it appears, because the looming recession will put more pressure on financial institutions and damage the values of their sovereign bond holdings. The ECB’s new forecast said euro zone gross domestic product could fall by as much as 0.4 per cent next year or expand by a maximum of 1 per cent. Its previous forecast had been for 2012 growth between 0.4 per cent and 2.2 per cent. “The intensified financial market tensions are continuing to dampen economic activity in the euro area,” the ECB said in a statement.
The plight of the European banks was highlighted Thursday by the results of stress tests conducted by the European Banking Authority. Banks will require €114.7-billion to boost their capital reserves, up from the €106-billion estimated in October.
One surprise was the extra capital required by the German banks, which will require more than double the €5.2-billion estimated in October. Germany’s ailing Commerzbank AG will have to raise the most.
European banks have until mid-2012 to achieve the new capital-to-assets ratio of 9 per cent. The fear is that many banks will simply shrink assets, putting downward pressure on prices.
The goal of the Brussels summit is to launch EU treaty changes that would enforce fiscal discipline among member countries to ensure the region never again sees another overspending spree that threatens to kill the €.-But Germany is already giving up hope that all 27 EU countries will agree to the pact, which would come with automatic sanctions on countries that violate debt and budget deficit ceilings. An agreement among the euro zone countries alone seems far more likely.