All eyes on ECB to charge to eurozone's rescue

10th November 2011, Comments 0 comments

As the sovereign debt crisis spreads to Italy, hopes are once again pinned on the European Central Bank to come to the rescue and prevent the worst -- a break-up of the eurozone, economists said on Thursday.

While Greece is struggling to put together a new government, Italy, the eurozone's third-biggest economy, has now been plunged into in political and economic crisis as well, sending its borrowing costs soaring to heights that could make it impossible for it to keep financing its 1.9-trillion euro ($2.6 trillion) debt.

"If the worst comes to the worst, only the ECB can save Italy and itself," said Berenberg Bank chief economist Holger Schmieding.

And the situation was getting "perilously close" to just such a point, he warned.

With Greece struggling to meet strictures imposed by the European Union and International Monetary Fund for another bailout, Italy is seen as too big to rescue.

Italian bond yields have now surged to a critical level above 7.0 percent, but the details of EU's bailout fund -- the European Financial Stability Facility or EFSF -- have not yet been agreed and so it lacks the firepower to help.

At the same time, other powers such as China and Japan are lukewarm about coming to Europe's rescue. So the heat is on the ECB once again to act, said Oddo Securities analyst Bruno Cavalier.

"The tension has become unbearable. Only large-scale intervention by the ECB can relieve that tension," because it alone is in a position to act quickly and decisively.

"If nothing is done, there is a risk the entire system will collapse," Cavalier said.

The ECB has been buying up Italian bonds in an attempt to keep a lid on yields.

It has done so under its so-called Securities Markets Programme (SMP), launched in the spring of 2010 as part of efforts to ease debt strains in the 17-nation bloc.

But the ECB is reluctant to make such purchases on an unlimited basis and its bond-buying so far has remained modest.

Capital Economics' senior European economist Jennifer McKeown estimated that even if 80 percent of the purchases since August have been Italian bonds, the sum involved would only amount to around 88 billion euros or 5.0 percent of Italy's outstanding debt.

"We estimate that roughly 700 billion euros might be needed to put Italy's public finances on a stable footing, suggesting that the bank would have to do far more to draw a line under the crisis," McKeown said.

"Desperate times call for desperate measures and if policymakers fail to come up with a way of boosting the EFSF's firepower, the risk of a collapse of the eurozone's financial system might ultimately force the ECB to step in," she said. "But we do not expect it to come to the rescure in the near future."

Schmieding at Berenberg Bank called on the ECB to act as forcefully as the US Federal Reserve, the Bank of England, the Bank of Japan or the Swiss National Bank to calm markets.

While the ECB had so far bought or pledged to buy assets worth roughly 2.7 percent of eurozone gross domestic product (GDP), levels purchased by both the Bank of England and the Fed stood at around 18 percent.

So if the ECB were to match that, that "would make a difference of about 1.4 trillion euros. That would be truly impressive," Schmieding said.

At his inaugural news conference last week, the ECB's new president Mario Draghi appeared loathe to bail out governments who had wantonly overspent.

The bond-buying programme was "temporary," "limited" and justified purely on monetary policy considerations and the key to solving the debt crisis lay in the politicians' hands, Draghi insisted.

"Draghi's message is clear: the ECB won't be the lender of last resort for governments," said RBS economist Nick Matthews.

But Berenberg Bank's Schmieding believed the ECB will have no choice but to act eventually.

"The endgame has started. Italy will probably need help soon," he said.

Nevertheless, the chances that the EFSF would be able to stabilise Italy "are no more than one in three," he said.

That meant "the crisis could get worse over the next two months before the ECB finally concludes that it is the only line of defence left and steps in decisively," Schmieding said.

© 2011 AFP

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