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Pivotal ECB Meeting Offers Test of Draghi's Pledge to Defend Euro

Sunday, 29 July 2012 03:10 PM

Mario Draghi may not need to show his money this week, but impatient markets will be unforgiving if the European Central Bank chief does not flesh out his dramatic promise to do whatever is needed to save the euro.

Given the threat that the long-running eurozone crisis poses to the global economy, Thursday's ECB policy-setting meeting and subsequent news conference were always going to be important.

But they have become pivotal since Draghi vowed in London last Thursday that "within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."

Specifically, Draghi said the ECB had a mandate to act if diverging borrowing costs were disrupting the transmission of monetary policy across the 17-country single currency area.

This is patently the case. The ECB's interest rate cut on July 5 to 0.75 percent has failed to reduce the giddily high cost of money for governments, banks and companies on the rim of the bloc, notably Spain and Italy. Sovereign yields in Germany and the Netherlands, by contrast, are negative.

Yet even as capital flees the periphery and eurozone output shrinks, few economists think Draghi is ready to announce that the ECB is resuming secondary-market bond purchases to lower yields, a policy it has pursued in the past with limited success.

The assumption is that the ECB wants to share the burden with the eurozone's government-financed rescue funds. Bond buying is controversial in Germany and other creditor states, which fear they take pressure off debtors to reform, and so Draghi will need time to forge a political consensus.

"The chances are that the ECB will need longer to calibrate its strategy. It will probably take at least until September for the ECB to be able to launch a new program," said Lena Komileva, chief economist at G+ Economics, a London consultancy.

Komileva favors a radical plan whereby the ECB would sell German bonds and buy Spanish and Italian debt to cap borrowing premiums. "The pressure is on the ECB to think of a creative way to tackle systemic fault lines in the euro area," she said.


As if the ECB needed reminding of the depth of the crisis, figures on Tuesday are likely to show that the eurozone's jobless rate rose to 11.2 percent in June from 11.1 percent in May.

"If we are not yet at a policy of 'growth at any price', the importance ascribed to growth in political circles has certainly increased - which gives political cover to monetary policy action," Paul Donovan, an economist with UBS, said in a report.

But whatever strategy the ECB adopts, the economic fissures in the eurozone, accentuated by the poor competitiveness of the periphery, means growth is not about to come roaring back.

"Over a 10-year horizon I'm positive, but in the short run it's got to carry on being painful," said Richard Barwell, an economist with Royal Bank of Scotland in London. "We need to condition ourselves to the fact that we're going to live with this for a long, long time."

The United States is doing better than Europe but is hardly a role model. Figures on Friday are likely to show that non-farm payroll jobs rose 100,000 in July, up from 80,000 in June, while the unemployment rate held steady at 8.2 percent.

Like America's 1.5 percent rate of economic growth in the second quarter, that would be uncomfortably sluggish for President Barack Obama, hoping for a growth spurt to boost his re-election prospects in November.

But few think it would be weak enough to push the Federal Reserve into a third round of asset purchases, dubbed quantitative easing, to drive down borrowing costs and so bolster businesses and consumer confidence.

Economists expect the U.S. central bank's policymakers, who gather on Wednesday, to sit on their hands for now.

"If we get to the September meeting and the Fed, looking at the latest data, sees the economy running at less than a 2 percent GDP pace, they're likely to act," said Bill Adams, an economist with PNC in Pittsburgh.

"We'll need to see a stronger job market, more in line with expectations that we had coming into the year of sustained, moderate growth, to move QE3 off the table," Adams added.

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Sunday, 29 July 2012 03:10 PM
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