European Central Bank President Mario Draghi signaled the ECB could do more to fight the debt crisis as long as governments push the euro area toward a fiscal union.
“A new fiscal compact” is “definitely the most important element to start restoring credibility,” Draghi said in an address to the European Parliament in Brussels today. “Other elements might follow, but the sequencing matters. It is first and foremost important to get a commonly shared fiscal compact right.” Draghi didn’t specify what more the ECB could do and said the central bank’s bond purchases “can only be limited.”
Still, he “appeared implicitly to hold up the offer of a significantly higher pace of debt purchases” and “potentially other measures, provided that euro-area governments were to commit to a new fiscal pact,” said Julian Callow, chief European economist at Barclays Capital in London.
The ECB yesterday joined forces with the Federal Reserve to cut the cost of emergency dollar loans to banks outside the U.S. While the coordinated action fuelled a global stock market rally, the yield on Italy’s 10-year bond is still close to 7 percent as contagion spreads to the euro region’s core.
The euro initially fell on Draghi’s remarks before rebounding to trade at $1.3486 at 1:25 p.m. in Frankfurt. The Stoxx Europe 600 Index also recouped its losses.
“Draghi is trying to manage market expectations to make people understand the ECB won’t behave like the Bank of England and the Federal Reserve,” Michala Marcussen, global head of economics at Societe Generale in Paris, told Bloomberg Television. “It doesn’t mean it can’t be supportive.”
The ECB unexpectedly cut its benchmark interest rate by a quarter point to 1.25 percent earlier this month, and all but one of 26 economists in a Bloomberg News survey predict another quarter-point reduction when policy makers meet on Dec. 8.
Draghi said the central bank’s bond purchases aim solely to ensure its rates are transmitted on markets, not to create new money or “subsidize governments.”
The ECB is already lending banks as much money as they ask for in an attempt to stimulate the flow of credit to households and businesses.
“The ECB has created an enormous amount of liquidity, and we see now that this liquidity is being redeposited with the ECB deposit facility,” Draghi said. “Which means it is not so much the amount of liquidity that is the matter, but it’s the fact that this liquidity is not actually circulating.”
The most important thing for the ECB to do is restore the flow of credit to the economy, he said.
“We have observed serious credit tightening in the most recent period, which combined with the weakening of the business cycle doesn’t bode at all well for the months to come,” Draghi said.
European leaders will meet next week to discuss the next steps in stopping a crisis that will soon enter a third year. Draghi’s approach is backed by German Chancellor Angela Merkel, who says politicians must drive the euro region toward a fiscal union rather than rely on the ECB’s bond purchases.
“Governments must restore their credibility vis-a-vis financial markets,” Draghi said.