NOVEMBER 18, 2011, 7:26 P.M. ET
The European Central Bank and Germany firmly rejected calls from euro-zone politicians to bail out Italy and other struggling euro members by intervening massively in bond markets, insisting that the central bank's credibility rests on its political independence and focus on fighting inflation.
ECB President Mario Draghi, in his first speech since taking the position this month, put the onus on euro-zone national governments to solve the crisis of confidence in the region's public debt, criticizing politicians for failing to quickly carry out their own anti-crisis measures.
"Where is the implementation of these long-standing decisions? We should not be waiting any longer," Mr. Draghi said in a speech to bankers and policy makers in Frankfurt.
For days, many world politicians, investors and economists have clamored for the ECB to embrace a role of lender of last resort, saying it has the means to prevent the euro zone's financial system from collapsing. But the Italian central banker's remarks confirmed that the ECB isn't about to drop its aversion to large-scale government-bond purchases.
Speaking after Mr. Draghi on Friday, Jens Weidmann, president of Germany's Bundesbank, reiterated his own opposition to greater bond purchases.
"The economic costs of any form of monetary financing of public debts and deficits outweigh its benefits so clearly that it will not help to stabilize the current situation," Mr. Weidmann said. German Finance Minister Wolfgang Schäuble also said massive intervention risked endangering the euro's stability.
Despite a perception among some analysts that the German public and policy elite stand as the main obstacle to greater ECB activism, the decision on how much to aid euro-zone governments ultimately rests with the bank's fiercely independent governing council, which isn't yet ready to rescue governments by printing money.
The ECB has been buying government bonds of Greece, Italy and other peripheral countries on and off for 18 months, but in limited amounts. On Friday, Italian and Spanish bond yields eased following ECB purchases, taking some pressure off European countries after a week that saw yields spiral higher.
The 10-year Italian bond yield fell by 0.05 percentage points to 6.74%, while the two-year yield fell 0.10 percentage points to 6%. The 10-year Spanish bond yield eased by 0.03 percentage points to 6.41%.
"The ECB is in and buying in small size," a trader said.
But senior politicians from Spain, France, Ireland and other countries, in a public standoff with the ECB, have said the bank is only institution able to restore calm to bond markets by purchasing unlimited amounts of Italian and Spanish debt. This, they argue, would hold down those countries' borrowing costs and give them and others in Europe time to implement fiscal austerity and other reform programs until investor confidence returns, supporters of such a course say.
Many observers now say the ECB needs to get over its hang-ups about supporting government borrowing, lest Europe's currency union collapse.
The financial-market pressure for ECB action intensified this week as investors sold off the bonds of countries including France, Austria and Belgium, which have so far been seen as part of Europe's economically sound "core" rather than its financially wobbly "periphery."
Germany, Europe's biggest economy, has strongly backed the ECB's position. German government leaders, lawmakers and media have all argued this week that the crisis can be solved only by economic reforms at nation-state level.
Chancellor Angela Merkel repeated her desire Friday for changes to the European Union treaty to achieve better enforcement of budget discipline in the euro's members.
Ms. Merkel was speaking after an inconclusive meeting in Berlin with U.K. Prime Minister David Cameron. Mr. Cameron was seeking assurances that changes to the EU treaty, aimed at more tightly coordinating euro members' economies, wouldn't hurt the economic interests of the U.K., an EU member that doesn't use the currency.
In a thinly veiled reference to the ECB, Mr. Cameron said, "all the institutions of the euro zone have to stand behind the currency and do what is necessary to defend it." Ms. Merkel said there was no quick fix.
The ECB still hopes euro-zone governments will beef up their bailout fund, the European Financial Stability Facility, so that it can take over bond-buying duties from the central bank. Government leaders have given the EFSF €440 billion ($592 billion) of funds and the power to buy bonds of at-risk countries such as Italy, and are working on a plan to make those funds go further by using leverage.
But the governments have yet to implement the changes, leaving the ECB as the only firefighter now in euro-zone bond markets.
Mr. Draghi made his frustration at the slow pace clear. "We are more than one and a half years after the summit that launched the EFSF....We are four months after the summit that decided to make the full EFSF guarantee volume available. And we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five," he said.
Many ECB officials fear that if they were to bring down Italy's borrowing costs through vigorous bond purchases, they would take the heat off the country's political elite to reduce its budget deficit and enact growth-boosting structural overhauls. What's more, an ECB safety net for national governments would encourage irresponsible budget policies in future, a problem economists call "moral hazard."
"They don't want to release the pressure on governments to get in the position where they're part of the solution," Mr. Matthews said.
Mr. Draghi, who previously headed Italy's central bank, said that he wouldn't deviate from the ECB's anti-inflation mandate, saying the costs of a loss of credibility would be "huge."
That sits well in Germany. The ECB's headquarters are in Germany's financial capital, Frankfurt, and it is modeled after Germany's conservative central bank, the Bundesbank.
Given German aversion to buying government bonds—two of its top ECB officials resigned this year in protest over the policy—"it shouldn't come as a surprise that Draghi is pushing back" at calls from France and others for more aggressive action, said Thorsten Polleit, Frankfurt-based economist at Barclays Capital.
German economists worry that buying large amounts of government bonds will lead to a spike in inflation, which is already well above the ECB's 2% target.
Despite the ECB's caution, many analysts believe the spiraling debt crisis will eventually force the bank to give in and purchase bonds on a massive scale, even if that means overruling its German members and angering politicians in Berlin.
If Europe's current economic downturn escalates into a deep recession, the ECB may need to buy large amounts of bonds to stimulate the economy and prevent deflation. The Federal Reserve and Bank of England have already implemented such policies, known as quantitative easing.
If borrowing costs rise to ruinous levels in Spain and Italy, or if the crisis spreads to France, economists say the ECB's only choices will be to set aside its reservations and act—or watch Europe's monetary union unravel amid a wave of sovereign debt defaults.
"Faced with a choice of letting governments go belly up or keep buying bonds, they'll go with latter," Mr. Polleit said.
Even in Germany, the nation that is most wedded to a strict separation of central banking and government financing, the threat of an economic collapse around Europe is concentrating minds.
Some German officials are beginning to admit that national austerity measures may no longer be enough to prevent a bond-market collapse across the currency zone. If the only alternative is a financial meltdown in many of Germany's key trading partners, which would push Germany's economy into a deep slump, then Berlin may have to accept emergency ECB actions.
Germany's mass-circulation tabloid Bild dismissed calls for the ECB to act as "hysteria" on Friday, adding: "The European Central Bank has already sinned enough."
But conservative-leaning newspaper Die Welt predicted Chancellor Merkel's government might yet change its mind on the ECB question. Germans like to recall the hyperinflation of the 1920s as a fable about what happens when central banks print money—but the newspaper said they should also remember another interwar trauma: the deep austerity and mass unemployment the early 1930s under Chancellor Heinrich Brüning. The Bruning years are widely credited with worsening Germany's economic depression and fuelling the rise of the Nazis.
Even Germans might eventually prefer central-banking money printing to a massive economic crash, observers say. But the decision will still rest with the ECB.
European Bank Chief Pushes Back - WSJ.com
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