August 2, 2012

Draghi Tested on Euro Crisis

Monti pushes for banking license as Germany stands firm; benchmark rates held

Should European Central Bank (ECB) President Mario Draghi fail to come up with an effective tactic to quell market fears over the eurozone crisis, it could make the situation worse than ever.

That could be a tall order, however, as Germany persists in opposing the notion of a banking license for the European Stability Mechanism (ESM), which has been pushed by Prime Minister Mario Monti of Italy as a means of combating the crisis despite Germany’s opposition. Amid the controversy, both the ECB and the Bank of England (BoE) left rates and strategies unchanged.

Bloomberg reported Thursday that after Draghi’s bold words about protecting the euro last week, markets expect him to deliver some sort of drastic action to do so and to relieve pressure on bond yields, which have climbed steadily higher for Spain and Italy.

However, German officials immediately voiced opposition to the notion that the ECB could buy bonds on a large scale, saying that it was not its mission to do so. The opposition from within her own party makes it that much harder for German Chancellor Angela Merkel as well. She has said publicly she would support saving the euro but has not provided details on policies she would back.

Monti challenged German officials Wednesday by saying that the ESM would be granted a bank license. In Helsinki to meet with Prime Minister Jyrki Katainen of Finland, Monti pushed the envelope with Germany and said in a news conference, referring to the bank license strategy, “I think this would help, I think this will in due course occur.”

Monti is on a persuasion mission among the leaders of the eurozone to push for more drastic strategies that could be more effective in fighting the crisis. He had already been to Paris to meet with officials there, and was headed next to Madrid on Thursday to meet with Prime Minister Mariano Rajoy.

Bundesbank President Jens Weidmann had said after Draghi’s promise to keep the euro together “whatever it takes” that the ECB should not exceed its mandate to fight inflation. He also emphasized Germany’s importance in setting common strategy in the eurozone.

Economy Minister Philipp Roesler of Germany said in the report after a weekly cabinet meeting, in which he stood in for Merkel, “The chancellor and we have discussed it and we are united that a bank license cannot be our way.” He added, “Fiscal discipline and economic reforms have to be the way forward. Other ways are not suitable.”

Monti, however, was critical of German and other insistence on austerity and surrender of control as the price for assistance to countries struggling with unsustainable bond yields. He attacked the lack of decisive action to bring down yields, and indicated that the repercussions of a lack of action on the part of European officials could include a change of attitude in Italy.

At a Helsinki press conference, he was quoted saying, “If the spread in Italy remains at this level for some time, then you’re going to see a non-EU-oriented, non-euro-oriented, non-fiscal-discipline-oriented government in Italy.”

He also said, “I only wish by the way that all components within the European system of central banks displayed the same degree of respect for the independence of the ECB as heads of governments do.”

Italians have begun to turn against the euro as the effects of the debt crisis drag on. However, despite Italy's budget difficulties, Monti said that it would not need a bailout, although the country may want Europe’s rescue funds and the ECB to buy its bonds so that yields come down to a more manageable level.

He was quoted saying, “Italy does not seem to be in need of any particular help, certainly not for the rescue of its economy nor for its budgetary needs. Italy may need help perhaps in relation with the slow pace which markets recognize the efforts taken and the results achieved by Italy or other countries for that matter.”

Jonathan Tepper, a partner at London-based investment research firm Variant Perception, said in the report, “The question is whether the Germans and the Finns have the stomach for a much looser ECB policy that is more suited to the south, and so far we haven’t seen much appetite for that. Neither seems to want to budge.”

Finland, despite Monti’s efforts, has also thus far been reluctant to support broader aid in the crisis. It demanded collateral for its share in the Greek rescue package and is determined to protect its AAA rating. It has also indicated that it will ask for collateral should a rescue of Spanish banks become necessary.

Katainen was quoted saying after his meeting with Monti, “We have been very critical on secondary market operations by rescue funds as we don’t believe that’s the right way to use money.” However, he acknowledged that the current state of sovereign bond markets was “not normal,” and “some sort of European solution” was necessary.

Whatever the resolution, officials at the ECB on Thursday declined to change the benchmark interest rate and left it at its current record low of 0.75%. At the BoE, QE was also left unchanged by the nine-member Monetary Policy Committee, with the quantitative easing target at 375 billion pounds ($585 billion). The committee also left its benchmark rate at 0.5%, unchanged from its last meeting.

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