UPDATE 2-Draghi sends strong signal that ECB will act

by on July 26, 2012 12:43 pm BST

Thu Jul 26, 2012 8:43am EDT

* Draghi says ECB will act to save euro

* Says addressing too high borrowing costs within mandate

* Italy, Spain fall sharply on hopes of action

* French finance minister welcomes statement

By David Milliken and Olesya Dmitracova

LONDON, July 26 (Reuters) – European Central Bank President
Mario Draghi pledged on Thursday to do whatever was necessary to
protect the euro zone from collapse, sending a strong signal
that inflated Spanish and Italian borrowing costs were in his

Fears about the euro zone’s future are intensifying with
Spain and Italy facing frenzied pressure on financial markets
and Greece holding crunch meetings with its international
lenders having failed to keep its repair plans on track, raising
fresh questions about its place in the currency bloc.

With the need for urgent action becoming increasingly
apparent, the ECB appears to be gearing up to flex its muscles,
something Madrid and Rome have been seeking for months.

“Within our mandate, the ECB is ready to do whatever it
takes to preserve the euro. And believe me, it will be enough,”
Draghi told an investment conference in London to mark the
beginning of the Olympics.

“To the extent that the size of the sovereign premia
(borrowing costs) hamper the functioning of the monetary policy
transmission channels, they come within our mandate,” he said.

The comments are Draghi’s boldest to date and suggest the
ECB is ready to defend Italy and Spain whose borrowing costs
have hit unsustainable levels.

The euro jumped after his remarks and Spanish and
Italian bond yields fell sharply.

The ECB has kept its sovereign bond-buying programme
mothballed for months. Internal opposition to reviving it is
stiff so focus will turn to what else the ECB could do following
Draghi’s remarks.

Economists think it could be forced to buy bonds again or
support struggling euro zone countries via the back door.

On Wednesday, ECB policymaker Ewald Nowotny broke ranks with
his colleagues, saying that giving Europe’s permanent rescue
fund a banking licence so that it could drawn on central bank
funds had merits. Draghi and others have previously rejected
that option.

Alternatively, the bank could act as the Federal Reserve and
Bank of England have, and opt for straight quantitative easing
— money-printing by another name.

“The comments about high government bond yields disrupting
ECB monetary policy transmission are interesting, in so far as
they hint at a possible attempt to circumvent the restrictions
on outright government bond purchases,” said Marc Ostwald,
Strategist at Monument Securities.

“Of course it remains to be see whether Herr Weidmann, Herr
Asmussen, Frau Merkel and Herr Schaeuble would agree with his
assessment,” he said, referring to the senior members of the
German government and its representatives at the ECB.

French Finance Minister Pierre Moscovici said Draghi’s
remarks on government bond yields were “very positive”.

The ECB rode to the rescue at a previous moment of acute
stress in December, launching a programme that eventually
created more than 1 trillion euros of three-year liquidity for
the currency area’s cash-strapped banks. That bought three
months of market calm which now seems a distant memory.


ECB members have been steadily upping their rhetoric in
recent weeks as delays in getting the euro zone’s bailout fund
up and running and Spanish banks recapitalised has pushed the
euro zone crisis back to boiling point.

Euro zone powerhouse Germany was put on a rating downgrade
warning this week along with fellow AAA members the Netherlands
and Luxembourg.

Draghi said at the weekend that the ECB had “no taboos” over
what it could or could not do. His fears about the failing
transmission of record low interest rates and uber-cheap loans
into the real economy chime with similar warnings from Bank of
France head Christian Noyer.

Draghi’s remarks “suggest that he has either convinced the
German members of the ECB that it is time to intervene verbally,
and if necessary follow through with actual intervention, or he
is willing to risk a showdown knowing that a vast majority of
the Council will support him,” said Riccardo Barbieri, chief
European economist at Mizuho International.

A crucial issue for the euro zone is that its bailout fund
would not be able to cope with supporting a country as large as
Spain or Italy without a major injection of firepower. In the
absence of that, the ECB is the only line of defence.

Draghi added that the ECB did not want to do things that
should be done by governments. He refused to speculate on the
chance of a country leaving the euro but said that the single
currency was “irreversible”.