ECB to Eurozone Governments: Get it Together

The European Central Bank on Wednesday put the onus firmly on euro zone governments to solve the bloc's debt crisis, dashing expectations it could take near-term action despite saying the currency area's economy was under increasing threat.

After the ECB left interest rates at 1 percent, President Mario Draghi said the bank was not open to trading with governments on the policy response to the crisis.

Increasingly alarmed by signs Spain's banking crisis is opening a new front in the debt crisis, some in financial markets had hoped Draghi would signal a readiness for the ECB to take fresh action if euro zone governments take bolder action.

Instead, Draghi said it was wrong for the ECB to fill a policy vacuum created by others and that there would be no quid pro quo between the central bank and governments.

"There is no sort of horse trading here," he told a news conference.

"Some of these problems in the euro area have nothing to do with monetary policy ... and I don't think it would be right for monetary policy to fill other institutions' lack of action."

The respite the ECB bought the euro zone early this year by injecting over 1 trillion euros into its banking system with twin 3-year loan operations (LTROs) has faded, with borrowing costs for troubled countries such as Spain soaring again.

Draghi played down prospects of any imminent third round of long-term money creation, saying LTROs and the ECB's dormant bond-buying programme were instruments that are in place but temporary and "not infinite".

"The issue now is whether these LTROs would actually be effective," he said when asked about another round.

Draghi said the decision to leave rates unchanged was taken by "broad consensus". He said a few members, but not many, of the bank had wanted a rate cut.

The ECB has never before lowered its main refinancing rate below 1 percent. Berenberg Bank economist Holger Schmieding said it was an open question whether the ECB would cut rates in July.

"In addition, the ECB offered no hint today that it may re-activate its two most important non-standard measures, that is the 3-year long-term refinancing operations (LTROs) and the purchases of sovereign bonds," Schmieding said.

"This suggests that it would take a major further escalation of financial tensions for the ECB to go beyond a possible rate cut in July," he added.

Draghi said markets tensions had not returned to the levels of late last year, when the ECB offered the 3-year LTROs, and stressed the euro zone was far from facing a situation like the one after the collapse of Lehman Brothers in Sept. 2008.

Although flagging the increasing threat to the currency area's economy, new ECB growth forecasts for 2012 were unchanged -- in a -0.5 to +0.3 percent range. The prediction for the following year was barely changed either.

"The economic outlook for the euro area is subject to increased downside risks relating in particular to a further increase in the tensions in several euro area financial markets and their potential spillover to the euro area real economy," Draghi said.

Markets were unsure how the ECB would react to a recent wave of weak economic data, knowing that the bank also wants to keep the pressure on euro zone leaders to tackle the crisis more effectively.

The euro was steady at $1.25 after the decision, Europe's benchmark stock market was up 2 percent after a recent steep fall.

DILEMMA

Jolted into action by Spain's banking crisis, EU leaders have started considering the form of economic union needed to make the bloc durable as well as more immediate measures to help Madrid.

But that end-game is still months or years away and in the meantime investors view the ECB as the institution with the firepower to keep the crisis in check.

"For the time being, the ECB is sitting on its hands as the bloc's economy and financial markets deteriorate further," said Nicholas Spiro, managing director of Spiro Sovereign Strategy.

"The message from today's ECB meeting is a worrying one: any mutualisation of euro zone debt is a long way off yet credible interim measures to shore up confidence will not be forthcoming for the time being," Spiro added.

In the run up to Wednesday's meeting, International Monetary Find chief Christine Lagarde said the bank had room to cut rates . Spain and other hard hit parts of the euro zone would also like the ECB to revive its bond buying programme to provide them with cover while they undertake planned repairs to their economies.

Euro zone unemployment stood at a record 11 percent in April, business confidence has slumped and surveys of manufacturing have hit three-year lows, adding to conviction that the bloc's economy is set to drop back into recession.

The bank's dilemma is that if does too much, pressure for government action falls. Yet if it does nothing, troubled sovereign debtors could find it harder and harder to finance themselves or maintain confidence in the banks that have bought much of their debt.

Draghi said the ECB would continue to supply euro zone banks with all the liquidity they ask for at least until Jan. 15 next year. It had said in October it would give euro zone bank unlimited access to central bank funding at least until July 10.

Before the crisis, the ECB allotted a certain amount in its refinancing operations for which banks had to put in bids. Since the crisis began, the ECB has extended the maturity of such operations to as long as 3 years and has lifted funding limits.

Most ECB watchers had expected it would keep its powder dry until after June 17 Greek elections and a crunch summit of EU leaders at the end of June, which Draghi and his colleagues hope will dispel any doubts about Europe's commitment to the euro.

There are also growing signs that a decision on a bailout for Spain's debt-laden banks will have been taken by the end of the month.