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European Central Bank doesn't act, disappointing markets

August 2, 2012 |  8:10 am

Mario Draghi
European Central Bank chief Mario Draghi vowed Thursday that the euro common currency is "irreversible," but the bank's decision to not ease borrowing costs for heavily indebted Eurozone members such as Spain and Italy drove markets into renewed turmoil.

Draghi had raised expectations that the central bank would act to reassure investors that the euro is a safe bet when he said last week that his institution would "do whatever it takes" to protect the common currency from bond market speculation.

Amid persistent recession in most of its member nations and unsustainable borrowing costs for those already saddled with massive debts, the European Central Bank (ECB) had been expected by investors and the troubled euro users to cut the interest rate or channel low-interest loans to member governments through a euro bailout fund.

At a news conference following a meeting of the ECB's governing council, Draghi said the bank officials acknowledged that "ongoing tensions in financial markets and heightened uncertainty" were damaging confidence in the common currency. He said strangling bond yields demanded by lenders were the result of "fears of the reversibility of the euro," which he deemed unacceptable and a perception that must be dispelled.

"The euro is irreversible," he proclaimed, adding that the bank was prepared to step in and buy up government bonds if and when the borrowing rates pose a threat to the currency's viability.

"Within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, [the ECB] may undertake outright open market operations of a size adequate to reach its objective," Draghi said of the bank's willingness to intervene in a crisis.

But the assurances failed to move investors. Interest rates on Italian 10-year bonds rose above 6% again, after a weeklong retreat following Draghi's confident declaration of ECB commitment. European stocks also declined, as did the euro against the U.S. dollar and the Japanese yen.

While Spanish and Italian officials had lobbied for definitive action by the ECB to reduce their borrowing costs, the head of Germany's powerful Bundesbank, Jens Weidmann, reminded central bank officials Wednesday that their main job was to fight inflation, not manage national budgets. Germany, Finland, Austria and other countries with good credit ratings fear their borrowing costs will rise if the ECB intervenes to lower government bond yields for the bigger debtors.

The ECB is prohibited by European Union treaties from lending directly to governments, but some officers were reportedly advocating indirect loans for member states through the Eurozone bailout fund, the European Stability Mechanism.

Draghi hinted at a divisive central bank discussion, reporting that the governors extensively debated the "severe malfunctioning" in the bond markets as well as the need for many of the struggling euro users to adopt fundamental reforms to reduce deficits and make their economies more competitive.

The central bank will work up means of easing euro members' borrowing costs in the coming weeks, Draghi said, while urging the euro member states seeking relief to pursue loans through the European Stability Mechanism, which would come with "strict and effective conditionality" -- meaning further demands for economic reform and austerity.

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Photo: Mario Draghi, president of the European Central Bank, insisted at a news conference Thursday following the meeting of the bank's governing council in Frankfurt, Germany, that the euro common currency is "irreversible." But the bank's decision to not reduce borrowing costs for troubled euro users disappointed financial markets, dragging down values on European stocks and the common currency. Credit: Daniel Roland / Agence France-Presse / Getty Images.

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