Draghi urged to take action as euro falters

By SCOTT REID
Published on 29/07/2012 00:00

MARIO Draghi, the boss of the European Central Bank (ECB), will this week face pressure to kick-start an economic recovery as the Eurozone crisis threatens to flare up again.

Analysts fear that without immediate action, yields on government bonds, particularly in Italy and Spain, could head back towards their recent record highs, while stock markets are likely to remain volatile.

Draghi sent a wave of optimism through markets on Thursday, saying the central bank was ready to do “whatever it takes” to save the single currency.

That has raised hopes that the ECB will step in and help lower the borrowing costs that are putting pressure on government finances in several Eurozone countries.

But traders believe that a sustained fall in yields below the critical 7 per cent mark beyond which borrowing costs could become prohibitive depends on rapid and decisive action from the ECB.

The central bank trimmed Eurozone interest rates at the start of this month but is expected to hold them at August’s meeting and news conference on Thursday.

However, officials will be pushed to outline a timetable for intervention, which could see the ECB resume its programme of buying sovereign bonds to try to drive down yields. There have also been suggestions that the Eurozone’s new bailout fund – the European Stability Mechanism – could be granted a banking licence, allowing it to borrow money from the ECB.

Both measures have faced criticism, particularly from Germany.

A brief statement on Friday from German chancellor Angela Merkel and French president Francois Hollande noted that the two countries were “deeply committed to the integrity of the Eurozone”. They did not spell out any specific course of action, however.

Erik Nielsen, global chief economist at UniCredit, said: “Draghi is putting his personal credibility on the line so my best belief is that if they come in, they won’t do it half-heartedly.”

Charles Diebel, head of rates strategy at Lloyds, added: “They [the ECB] obviously want to support the market but they run the risk of causing massive disappointment if they don’t follow through with something.”

Bank of England policymakers also meet this week, but are expected to sit on their hands after approving another £50bn of quantitative easing earlier this month. The bank’s money printing programme now stands at a heady £375bn, but there will be calls to push it further after last week’s worse-than-expected GDP data.

Howard Archer, chief European and UK economist at forecasting group IHS Global Insight, said policymakers would likely want to see what early impact the separate “funding for lending” scheme was having before considering further QE.

“In terms of immediate policy changes, August’s meeting of the Bank of England’s monetary policy committee appears to be a non-event.

“Nevertheless, the MPC certainly have a lot to discuss, and it will be interesting to see exactly what they make of the 0.7 per cent plunge in GDP in the second quarter.”

Archer said more QE looked “highly likely” in the fourth quarter, particularly if Eurozone woes dragged on.