ECB backing away from role of emergency lender

November 14, 2011

Italy's new Prime Minister, Mario Monti, desperately needs buyers for the country's bonds, but the European Central Bank is sending out signals that it won't become Europe's lender of last resort.

Mr. Monti faced his first test Monday when the treasury sold €3-billion ($4.15-billion) of five-year bonds. There were ample buyers, but it was a Pyrrhic victory: The yield demanded by the investors was so high – 6.29 per cent, a crisis level – that Italy won't be able to afford many more sales at that price. (A similar sale only a month ago went out the door at 5.32 per cent.) If the yield continues to rise, the Italian treasury could be shut out of the sovereign debt market.

World leaders, including U.S. President Barack Obama and British Prime Minister David Cameron, have urged the ECB to take a bigger role in ending the European debt crisis, which is sending bond yields up in almost every euro-zone country, including France, as the contagion spreads. In his parting TV appearance Saturday night, former prime minister Mr. Berlusconi also called upon the ECB to become the lender of last resort to keep the euro-zone debt markets from collapsing.

However, the bond sale came amid evidence that the ECB, led by Italy's Mario Draghi, has been an unenthusiastic buyer of the sovereign debt of the most deeply indebted euro-zone countries, among them Italy and Spain. In a news release, the ECB said it had purchased €4.48-billion of sovereign bonds in the seven days to Nov. 11 – less than half the amount it had spent in the previous week.

"The ECB continues its role of euro-crisis fire brigade, but only at half speed," said ING Bank economist Carsten Brzeski. He noted that key European central banks, above all Germany's Bundesbank, are increasing their resistance to bond purchases.

The slow pace of ECB purchases helps to explain why Italian 10-year bond yields leaped last week to a record 7.48 per cent, an unsustainable level that, if it persists, could trigger a bailout of Italy. Greece, Ireland and Portugal all required bailouts shortly after their 10-year bond yields surpassed 7 per cent.

On Monday, Jens Weidmann, the Bundesbank president who sits on the ECB's governing council, said the ECB should back away from becoming an emergency lender. "Monetary policy cannot and must not solve solvency problems of states and banks," he said. "This has to be decided by national parliaments. The participation of monetary policy for fiscal policy purposes must come to an end."

He urged Italy to summon the political will to fix its debt crisis. "Italy can master the current difficulties on its own," Mr. Weidmann said in a speech in Berlin.

While he is only one voice on the ECB's 23-member governing council, Germany exerts more influence on the council than any other country. Mr. Draghi's appointment to the ECB happened only after he was endorsed by German Chancellor Angela Merkel.

Many economists think the ECB is the only institution capable of preventing the debt crisis from spinning out of control and shutting Italy out of the debt markets, an event that would shatter the euro zone. Italy is the region's third-biggest economy and, with €1.9-trillion in debt, the world's third-most-indebted country.

Economists say the ECB should be pushed to the forefront because of the birthing pains of the zone's bailout fund, known as the European Financial Stability Facility. The fund has €440-billion of borrowing power and is having trouble reaching its new goal of €1-trillion.

"The market needs a large financial buyer. With the EFSF struggling, the only credible source is the ECB," Deutsche Bank economists Gilles Moec and Mark Wall said in a note published Monday.

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