Eurozone hits budget buttons after ECB, Fed take centre role

10th August 2011, Comments 0 comments

Emergency action on the eurozone crisis accelerated on Wednesday with a drop in Italian rates, and new budget moves in Rome and Paris after the European Central bank laid down its terms for shoring up the euro system.

Comments by US Federal Reserve chairman Ben Bernanke implying that the main US rate would remain close to zero for the next two years were also credited with calming threatened breakdown on financial markets in recent days.

Central banks have taken a central role in dealing with the trans-Atlantic debt crises, and it was only when the ECB resumed buying government bonds, believed to include Italian and Spanish bonds, that pressure eased on Rome and Madrid.

This appears to be in response to ultimatums from ECB president Jean-Claude Trichet who has called repeatedly for eurozone capitals to make a "quantum leap" in tightening up governance of public finances.

The eurozone debt crisis, now acknowledged to threaten the eurozone system unless there is rapid progress towards a new framework, has collided with, and is part of a wider and deeper crisis over US debt.

In the eurozone, the ECB has resumed the heavy purchase of debt issued by distresses countries now including Italy, the third-biggest eurozone country, and Spain.

France, the second-biggest and an "AAA" credit rated country, is also brushed by the crisis in that its borrowing rate has diverged further from the German rate recently.

The bigger picture is the risk of a so-called double-dip recession in the US and European economies, which would also hit emerging economies dependent on exports.

It was to ward off the threat of sharp downturn in the United States that the Federal Reserve said unusually on Tuesday that it would hold its key rate down for about two years.

In the eurozone, Berlusconi has called parliament back early from summer holidays for a debate on Thursday to approve a constitutional amendment requiring a balanced budget.

And he was meeting trade unions and business leaders on Wednesday to hammer out reforms which a month ago they had shied away from.

The talks on Wednesday come just a month after a special big austerity budget, which had to be followed a week ago by a crisis speech and then a pact with employers and unions for the economy.

But even these measures were followed by increased market pressure on Italy which formed part of emergency talks between global leaders at the weekend.

Italy benefited from a sharply lower rate of 2.959 percent when it tendered 6.5 billion euros ($9.3 billion) in 12-month bonds on Wednesday, well below the 3.67 percent it had to pay in a similar operation last month.

This was reportedly the result of heavy ECB buying of Italian bonds. Italian borrowing rates on the market shot up last week amid concern that Italy could be forced into needing a rescue like those granted to Greece, Ireland and Portugal.

In France, President Nicolas Sarkozy also promised new measures on Wednesday to slash France's public deficit in a bid to reassure markets.

The measures would be decided on August 24, Sarkozy's office said after he broke off a holiday on the French Riviera to return to Paris for an emergency government meeting on the crisis.

France, which currently chairs the Group of Seven highly industrialised nations, has become the subject of speculation about whether it will be the next G7 country to see its AAA rating called into question.

Finance Minister Francois Baroin said after meeting Sarkozy that the new measures would take into account "global uncertainty" and a historic downgrading of the US rating by Standard & Poor's.

The burst of activity came a day after Trichet warned on Europe 1 radio that the eurozone was in the midst of "the worst crisis since the Second World War."

In this context "we expect governments to do what we consider to be their work, their duty," he added.

"We have been extremely clear with the Italian government over recent days in asking for a number of decisions to be taken, which have been taken, and to speed up in particular a return to a normal budgetary situation," Trichet said.

Economists agreed the ECB now seems to be dictating its terms to indebted eurozone governments in exchange for financial aid that only the central bank is capable of mustering, epecially at short notice.

"The ECB is now accelerating the process of conforming to the standards it requires by really dictating here the changes it requires to provide support," Barclays Capital managing director Julian Callow told AFP.

Berenberg Bank senior economist Christian Schulz noted that in the case of Italy, "the ECB is the only institution which is credible enough to make a difference.

"The ECB is also the only one that can impose conditions on Italy," he said.

© 2011 AFP

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