NEWS,30.07.2012

Draghi under pressure to deliver euro pledge

European Central Bank (ECB) President Mario Draghi must back up his pledge to do what it takes to protect the euro when the bank's policymakers meet on Thursday or else face deep disappointment from investors hungry for, and expecting, immediate action. In his boldest comments to date, Draghi said last week that, within its mandate, the ECB was ready to do whatever it takes to preserve the euro, fuelling expectation it could revive its bond purchase programme as it did a year ago when it started buying the government debt of Spain and Italy.But that is far from certain. The ECB might instead explore new policy tools such as outright asset purchases, or quantitative easing, something its peers in Britain, the United States and Japan are already using to stimulate growth.There have also been recent suggestions that it could empower national central banks to broaden their asset buying abilities.The ECB is under intense pressure from within and outside the euro zone to intervene and bring those governments' soaring borrowing costs under control as the debt crisis deepens and increasingly poses a risk to the global economy. Reflecting the increased tension, U.S. Treasury Secretary Timothy Geithner is travelling to Germany, the euro zone's biggest economy and key to any euro rescue plan, on Monday to meet Germany's finance minister and Draghi. The ECB chief will also meet Bundesbank President Jens Weidmann, a strong opponent of the ECB's mothballed government bond purchase programme, ahead of Thursday's ECB meeting, a central bank source said. Italian and Spanish bond markets rallied after Draghi's comments last week, but fresh turmoil is on the cards if Draghi fails to persuade investors on Thursday that the ECB stands behind its pledge. "With expectations running high, the scope for disappointment at Thursday's ECB policy meeting has increased considerably," said Nicholas Spiro at Spiro Sovereign Strategy.The August meeting usually draws little attention and in fact the ECB used to skip the summer month's meeting until 2006 - the last year in which it took policy action in August.The ECB could well break with tradition this year.Huw Pill, economist at Goldman Sachs and a former senior ECB official, said the ECB could decide on Thursday to buy unsecured debt of bank or firms via the national central banks to spare its own balance sheet. "We forecast the announcement of measures to permit national central banks to purchase private-sector assets under their own risk to implement 'credit easing', within a general framework approved by the Governing Council," Pill said. Another cut in interest rates seems less likely as the ECB assesses the impact of its July rate cut to a new record low at 0.75%. At that meeting, the bank also decided to stop paying banks interest on their overnight deposits with it.A poll showed 44 out of 69 economists expect the ECB to cut rates again by the end of the year, with seven saying the bank would cut already in August. Draghi's remarks last Thursday left many in the market wondering whether his message had been intended and if so how far the ECB would be prepared to go before it reaches the limits of its mandate."If you had just landed from planet Mars, and this was the first time that you had heard the ECB speak on this issue, you might think that it was about to fire a big bazooka at sovereign bond markets," said David Mackie, economist at J.P. Morgan."But, having listened carefully to the central bank over the last two and a half years, we don't think that is about to happen," he added. Germany's Bundesbank doused hopes for renewed bond purchases on Friday, saying it still opposed the programme. Instead the ECB would rather see Europe's permanent ESM bailout fund start buying the bonds of euro zone strugglers, but the fund's limited fire power could make its intervention less effective. One solution would be to give the ESM access to ECB funding and Austrian policymaker Ewald Nowotny last week broke ranks with his colleagues, saying such a step had merits. Draghi's candid remarks took some of his fellow Governing Council members by surprise, having not agreed with them before hand on the message he would send. This has prompted concerns Draghi may have raised false hopes in the market."Nothing new has been discussed (on action ECB could take), but Draghi is not a man to make comments lightly and at the end of the day he is the one calling the shots," said a euro zone central bank source. "There was always going to be a time when Draghi decided he had to act," the source said. Draghi did not have a pre-written speech when he spoke in front of an investment conference in London on Thursday and only much later that day did the ECB publish the transcript online.Another source said Draghi was not flagging an imminent move, and any action would likely come only in September or October, in conjunction with euro zone governments, and with a request from Spain for a bailout programme, which Madrid was still trying to avoid.

Spanish economy shrinks faster

Spain slid deeper into recession in the second quarter as a tough new round of austerity to head off the budget crisis that threatens the euro took effect both on overall demand and the price consumers have to pay for goods. The first official numbers on gross domestic product showed the economy shrank 0.4% from the previous quarter after contracting 0.3% in the first three months of the year. The economy was 1.0% smaller than a year earlier. Consumer prices according to both Spanish and EU methodology rose 2.2% year-on-year, with the EU-harmonised increase above forecasts being due to medicine price hikes put in place by the government to save money and deflate the deficit. Economists warned price hikes, and especially a 3-point rise in value-added tax due to come into effect in September, would distort consumer prices while the deepening recession reflected slower domestic demand. That will further weaken the government’s efforts to get the economy growing again - vital if it is to meet targets on reducing its budget shortfall and halting a market-inspired crisis in how it finances its debt. “To properly follow Spain's economic reality, I would look at domestic service inflation, which is where we’ll see stagnation and even deflationary pressures. Consumption remains very weak,” economist at Madrid-based broker Intermoney Jose Carlos Diez said. Spain slipped into the second recession since 2009 in the first quarter and is expected to continue to shrink until well into 2013 as consumers and businesses rein in spending and the eurozone debt crisis saps investor confidence. Fears over the health of Spain’s economy as it fights to reduce its public deficit has lifted funding costs to euro-era highs in recent weeks leading many to think an application for a full-bailout could soon become inevitable. A full breakdown of the growth data will be published August 28, while the final price data will be available August 14.