ECB's call to arms met with reluctance

ANALYSIS:THE EUROPEAN Central Bank (ECB) is now seen to be "all out" in a campaign for tougher and more unified political action to douse the flames of the sovereign debt crisis. The bank's clamour grows stronger by the day but it is making little headway.

Even as a succession of top-level ECB officials stepped up the rhetoric yesterday, German chancellor Angela Merkel and French president Nicolas Sarkozy dismissed demands to enlarge the EU-IMF bailout fund and grant a common euro zone guarantee on sovereign bonds.

Both notions present problems for political leaders, although attention at present seems to centre on ways of increasing the fund’s borrowing capacity.

Backroom bickering over what to do next points to a high-stakes summit in Brussels next Thursday when EU leaders gather for their final meeting of the year. Whether they decide to take any new initiative remains in the balance, but the ECB has made clear its concern that existing measures do not go far enough.

Why is this so and what can be done? For one thing, the bank is very keen to unwind the support measures it has in place to prop up ailing euro zone banks and boost demand for the debt of weakened single currency sovereigns.

For another, financial market tension arising from the lack of investor confidence remains a clear threat to all euro members. With Belgium and Italy joining Portugal and Spain in the danger zone in the wake of Ireland’s bailout, the underlying risk remains that the crisis cascades out of all control.

This is the implicit, foreboding message of the bank’s newly published stability review, which warns the present situation is “fraught with risks” and says banks could encounter difficulties as they try to refinance no less than €1,000 billion of debt in the next two years.

Cue ominous words from a line of ranking ECB officials, first among them Vitor Constâncio, who deputises for bank president Jean-Claude Trichet. Constâncio said enlargement of the fund would be helpful and wants “more flexibility” in euro zone resources.

His was one of many ECB voices as senior policymakers lined up to add pressure. From Italian central bank governor Mario Draghi came a call for control over the ECB’s exposure to crisis measures and a demand for “credible” action from euro zone governments.

There were similar remarks from his Austrian counterpart, Ewald Nowotny, who said “extraordinary measures can’t become normality”. In Luxembourg, central bank governor Yves Mersch said he was “disturbed” by the extent of market uncertainty caused by unhelpful comments.

This follows stern public words from Trichet himself, and figures such Bundesbank chief Axel Weber and ECB executive board member Jürgen Stark. There may be different strands to the argument from the bank’s figureheads, but the net impact stands as forceful push for more action from political leaders.

Although some governments would be happy enough to build up the armoury, Merkel is not yet ready to cede any more ground and Sarkozy seems reluctant to budge unless he can jump in time with the chancellor.

At the root of the dilemma is concern that any outright increase in the €440 billion European Financial Stability Facility, the largest individual element of the €750 billion scheme, requires parliamentary approval in member states. This is seen as a non-runner in Germany, particular as the Irish bailout takes less than 10 per cent of the total fund.

There are alternatives but they present difficulties of their own. One is to allow a downgrading of the fund’s triple-A rating, thereby increasing its borrowing capacity. The problem is that borrowing costs would rise and undermine the fund’s investment status.

Another is to ask the ECB or member states to capitalise the fund, whose borrowing capacity currently relies on sovereign guarantees. The problem with an ECB capitalisation is that it would compromise the bank’s cherished independence. The problem with member state capitalisations is that parliamentary approval would be required.

Empowering the fund to buy sovereign bonds raises the same problem. Room for manoeuvre is curtailed on the sticky ground in which Europe’s leaders find themselves and the fact they are meeting next week means the pressure to act intensifies.

They might well try to brazen it out until the new year – in anticipation of more favourable market conditions as liquidity increases – but the resounding message from Trichet and his colleagues points to high anxiety.