ECB chief needs to be much bolder

ANALYSIS: Trichet has the power to calm market fears – he should exercise it, writes DAN O'BRIEN,Economics Editor

IF THE massive rescue package agreed by the European countries in early May was about calming market fears, it is clearly not working.

Yesterday’s developments in the government debt market saw yields on Irish government bonds soar past the peaks reached at the height of the crisis in late April and early May. Other peripheral countries also experienced big increases. This is alarming.

The EU rescue package brought the situation back from the brink in May, but within weeks, yields on the weaker countries’ debt began to rise, sometime in leaps, sometimes in baby steps, but almost always in a ratchet-like fashion.

Apart from Greece, Ireland and Portugal have been the most seriously affected. Spain is in the firing line, but to a lesser extent.

The latest ratcheting up of yields for the peripheral euro-area countries appears to have been caused by a number of factors, including a continued weakening of sentiment towards Ireland. Negative comments on European banks in the Wall Street Journal and a downgrading of AIB and Bank of Ireland by Dublin stockbrokers Davys added to fears yesterday.

The euro area can be likened to 16 climbers roped together on a mountain in appalling weather conditions. Greece has gone over the edge. The other 15 can easily take the strain of keeping the Greeks dangling, however uncomfortable it may be for them. Ireland is now closest to the edge, and moved even closer yesterday. Just behind it is Portugal, and a good bit further back is Spain. If all three go over, 12 countries will be supporting four, something that the May bailout package anticipates as a worst-case scenario.

Thankfully, the mountaineering metaphor is less applicable since the European Central Bank was given new powers as part of the rescue package in May. These powers allow it to go into the market where government bonds are traded and, using the money it prints, buy up bonds.

There is, in theory, no limit to the amount it can print. This means there is no limit to the amount it can buy. This is a formidable weapon. It has been timid in deploying it.

Whereas it bought tens of billions worth of bonds in the weeks after it was first given this power, in July and August it effectively ceased doing so. Over the past three weeks, it has been more active, buying more than €650 million worth. But this is a small amount relative to the size of the market, and it has clearly not stemmed the panic.

The future of the euro is not in question yet, but if the slide is allowed to continue, it could be.

This is now the European sovereign debt crisis, Mark II. Jean Claude Trichet needs to be much bolder. He has the power to calm the panic. He should exercise it.