As Italy edged toward crisis, ECB stepped back
By Howard Schneider,
As Italy’s borrowing costs spiked and its government neared collapse last week, the European Central Bank reacted in an unusual way for an organization serving as the euro region’s chief financial fire brigade.
It slowed its purchases of government bonds, a step that likely contributed to the jump in Italy’s interest rates above the 7 percent threshold and arguably hastened Prime Minister Silvio Berlusconi’s departure as Italian politicians rushed to contain the country’s growing financial risks.
According to ECB statistics released Monday, the bank cut its purchases of government bonds last week to about $6 billion, only half the amount of the week before.
While the bank does not break down its bond purchases by country, analysts say the data from last week show the ECB in an unpredictable and somewhat unnerving dance with countries such as Italy and Spain that may be at risk of needing a bailout.
It continues to intervene in European bond markets and now holds about $260 billion in loans issued by financially strapped nations. But the timing, amounts and intent of the purchases remain opaque, and include a willingness to let countries such as Italy remain under market pressure in an effort to ensure that political and economic reform continues. The risks are large: losing control of the process and allowing confidence in Italy or Spain to slip so far that those nations lose the ability to borrow money on their own.
The bank is “stuck in a Catch-22,” said ING economist Carsten Brzeski. If it intervenes too deeply in bond markets and holds down interest rates regardless of a nation’s fiscal progress, it signals to politicians that they don’t have to do as much; if it intervenes too little, Spain or Italy could slip over the same cliff as Greece, Portugal and Ireland and need a bailout.
Even with the change of government in Italy, a Monday auction of five-year bonds saw the government pay rates of nearly 6.3 percent — the highest since the country adopted the euro and more evidence that the ECB was not moving aggressively to hold down the country’s borrowing costs.
Some European leaders and many economists argue that a stronger and more transparent role for the ECB in regional bond markets is the only durable solution to problems that have threatened to pull apart the 17-nation currency union. Europe’s other firefighting tools, largely the European Financial Stability Facility, have been slow to get off the ground, and many analysts argue that it will never raise the trillion or more dollars needed to settle European bond markets.
However, ECB officials — including the bank’s new Italian president, Mario Draghi, a critic of Berlusconi — continue to resist taking a larger role.
Since taking over, Draghi has said that the “securities market program” will remain temporary and is not meant as a substitute for governments implementing sound fiscal policy.
Germany and other of the euro region’s more fiscally prudent countries oppose strong central bank involvement in solving the debt crisis for fear that open-ended bond-buying would force the bank to expand the money supply and cause inflation.
The ECB “cannot and should not solve the financial problems of states,” Jens Weidmann, head of the German Bundesbank and a German representative to the ECB governing board, said on Monday, the Associated Press reported from Berlin. “These decisions must be made by national parliaments.”