ECB Hints at Action If Euro Zone Adopts Fiscal Pact

CNBC,

1 December, 2011

The new head of the European Central Bank signaled on Thursday he was ready to take stronger action to fight Europe's debt crisis if political leaders agree next week on much tighter budget controls in the 17-nation euro zone.

Speaking a day after the world's major central banks took joint action to provide cheaper dollar funding for starved European banks, Mario Draghi painted a dark picture of the state of the banking system.

"What I believe our economic and monetary union needs is a new fiscal compact—a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made," he told the European Parliament.

"We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short-term. Our answer is that it is definitely the most important element to start restoring credibility.

"Other elements might follow, but the sequencing matters."

Draghi did not spell out what action the ECB might take, but it is under huge political and market pressure to massively step up purchases of euro zone government bonds or to lend money to the IMF to support ailing Italy and Spain. to boost liquidity.

In response to lawmakers' comments, he added that the ECB had scope to act within the European Union treaty and the most important thing was to make sure that frozen credit channels start to work again.

In the short-term, economists expect the central bank to relieve pressure on banks and an economy heading into recession by announcing longer-term cheap liquidity tenders with easier collateral rules and cutting interest rates next week.

Draghi, who faces some of the toughest decisions in the currency's 12-year history after just one month in the job, said the ECB was aware many European banks were in difficulty because of stress on sovereign bonds, tight inter-bank funding markets and scarce collateral.

"Downside risks to the economic outlook have increased," he said, noting that the ECB's mandate was to maintain price stability "in both directions"—a rare indication that the bank is concerned about deflation risks as well as inflation.

Two years into Europe's debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, south European banks are bleeding deposits and a recession looms, fuelling doubts about the survival of the single currency. ID:nL4E7MU070

The Euro [EUR=X  1.3476    0.0014  (+0.1%)   ] and European stocks [.FTEU3  976.02    -6.00  (-0.61%)   ] were steady after surging on Wednesday after the joint intervention by the U.S. Federal Reserve, the ECB and the central banks of Japan, Britain, Canada and Switzerland.

But safe-haven German bond futures crept up further after Draghi said the ECB's bond-buying programme was only temporary and limited. GVD/EUR

Spain and France both found strong demand for bonds at auctions on Thursday, cheering markets, but Madrid had to pay sharply higher yields above 5 percent on 4, 5 and 6-year debt.