Rapidly deteriorating economic data and renewed bond market assaults on battered euro zone countries are ratcheting up pressure on the European Central Back to act quickly and boldly after disappointing the markets last week.
That could happen as early as this week, now that the ECB has laid the groundwork for aggressive buying of short-term government bonds issued by Spain and other troubled borrowers.
ECB president Mario Draghi has offered no timetable for any move. But political and market pressures in the wake of worsening economic news – notably from Italy on Tuesday – may end up dictating the pace of the central bank's response.
At its regular monthly policy meeting last week, the ECB failed to ease monetary policy either through lower interest rates or renewed bond purchases, despite well-publicized public comments the previous week from Mr. Draghi that the ECB would do whatever is necessary to safeguard the euro.
But at a press conference after the ECB meeting, Mr. Draghi outlined in considerable detail what an intervention would look like and what governments would have to do to qualify. These conditions, which Spain has already rejected, include what amounts to a bailout request to the European rescue fund and adherence to strict guidelines on structural reforms and fiscal consolidation.
"Draghi made a very strong and unambiguous commitment to intervene as necessary to avoid a Lehman-style calamity [in the euro zone]," economist Ed Yardeni, president of Yardeni Research Inc., said in a note.
Mr. Draghi offered no time frame for ECB action. "The when is when governments have actually fulfilled the necessary conditions. … At that point, we may act, if needed, along the lines that I have illustrated."
Italian and Spanish two-year bond yields climbed for the first time in a week after Italy reported that its economy closed out the first half of the year with its fourth consecutive quarterly contraction. Gross domestic product fell 0.7 per cent from the first three months and 2.5 per cent year over year. It was the biggest decline since the depths of the Great Recession. "Italy will need more than bond purchases from the bailout funds and ECB to get it out of trouble," said Ben May, European economist with Capital Economics in London.
The German economy, the last bulwark in the euro zone, also showed more signs of fraying, as manufacturing orders slid 1.7 per cent in June from the previous month – twice what economists had forecast. Orders from Germany's euro zone partners plunged 4.9 per cent. In June, the Bundesbank pegged German growth this year at an anemic 1 per cent. But that was before a sharp drop in industrial production, a further fall in consumer confidence and signs that the country's low jobless rate is starting to creep up.
Still, Germany has so far escaped the deepening slump afflicting a large swath of the 17-country euro zone. The European Commission forecasts a decline in regional GDP of 0.3 per cent. But some economists say that's on the optimistic side, noting that such large economies as Italy and Spain will remain mired in recession, while France and Germany will struggle to maintain modest growth.
The Bundesbank and its president, Jens Weidmann, oppose both ECB bond purchases and looser monetary policy on the grounds that such measures would boost the risks of inflation without solving the deep-seated fiscal and competitive problems at the heart of the debt crisis.
Critics of a more activist role for the ECB agree.
But German Chancellor Angela Merkel's government has come out strongly in favour of Mr. Draghi's bond-purchasing strategy – if only to buy more time for Spain and Italy to stabilize their finances.