Germany Stiffens Opposition to Aid Boost in Face-Off With ECB

Germany stiffened its opposition to expanding government-financed aid for debt-plagued euro nations, leaving the European Central Bank to shoulder the bulk of the burden of fighting the crisis.

With Chancellor Angela Merkel ruling out an increase in the euro area’s 750 billion-euro ($1 trillion) emergency fund, Germany yesterday put the spotlight on the ECB by endorsing a possible boost in its capital.

Discord between Merkel and ECB President Jean-Claude Trichet and Luxembourg Prime Minister Jean-Claude Juncker on the eve of a European Union summit evokes the tensions during the first phase of the debt crisis, when Germany held out for more than two months before consenting to a loan package for Greece.

“The consequence is a stalemate that leaves us with a familiar sense of déjà vu,” Ken Wattret, chief euro-area economist at BNP Paribas SA in London, said in a note to investors. “Market tensions are likely to resurface, as governments remain very publicly divided on the appropriate way forward.”

The euro weakened after Moody’s Investors Service said today it may cut Spain’s Aa1 credit rating. The country lost its top rating in September. The currency declined 0.4 percent to $1.3321 at 12:32 p.m. in Berlin.

The review is “not good for spreads or the euro,” Charles Diebel, head of market strategy at Lloyds TSB Corporate Bank in London, wrote in an e-mailed note.

Spreading Contagion

Evidence that core countries in Europe are also at risk mounted yesterday when Standard & Poor’s cut the debt outlook for Belgium, which is stuck with a caretaker government six months after inconclusive elections. Belgian bonds fell, pushing the risk premium against comparable German notes up 2 basis points to 102 basis points.

“The main risk to economic recovery and the main risk to market performance in 2011 is the euro zone,” Andrew Popper, chief investment officer at SG Hambros Bank Ltd., said on Bloomberg Television’s “On The Move” with Francine Lacqua. “The euro zone will be the dominant problem.”

Merkel, in a speech laying out Germany’s position for the EU summit, said that “strict conditions” will be tied to aid for distressed countries under a planned permanent rescue system that leaders are set to discuss.

‘Last Resort’

“For me it’s important that financial aid will, also in the future, be granted only as a last resort,” Merkel told lower-house lawmakers in Berlin today.

EU leaders start a two-day summit at 5 p.m. in Brussels tomorrow with the focus on the permanent crisis-fighting system to be launched in 2013.

Proposals facing German resistance include using EU money to buy distressed governments’ bonds directly or in the secondary market, boosting the fund’s size or redrafting guarantee rules to make more of the money available.

The need for a cash buffer to maintain an AAA credit rating puts the bailout fund’s effective lending capacity as low as 230 billion euros. Abandoning the top rating isn’t up for discussion, an EU official said yesterday.

Leaders of the 16 euro governments continue to be prodded by Trichet and the International Monetary Fund, contributor of 250 billion euros to the European rescue packages.

Trichet said euro-area governments need to put more money on the table to halt the crisis instead of depending on the central bank to soothe markets by buying the bonds of distressed governments.

‘Maximum Flexibility’

“We’re calling for maximum flexibility and maximum capacity, quantitatively and qualitatively,” Trichet told reporters in Frankfurt in remarks released yesterday.

The ECB settled 2.667 billion euros of bond purchases last week, a 23-week high for a program without unanimous support on the bank’s council. With 72 billion euros of potentially loss- making bonds now on its books, the ECB may ask national central banks for more capital, an official with knowledge of the situation said yesterday.

The ECB’s other main crisis-fighting step is to provide unlimited liquidity for commercial banks, a policy it extended on Dec. 2 into the second quarter of 2011.

Germany, Europe’s largest economy and biggest contributor to aid packages for Greece and Ireland, is against tinkering with the 440 billion-euro European Financial Stability Facility, set up in May and underwritten by euro-area governments, a German official told reporters in Berlin yesterday.

Irish Banks

Ireland on Nov. 28 borrowed 17.7 billion euros from the facility as part of an 85 billion-euro package to plug the fiscal holes from the bursting of its property bubble and near- collapse of its banking system.

“These instruments are far from exhausted,” European Commission President Jose Barroso told the European Parliament in Strasbourg, France yesterday. “If need be, they can be improved and adapted much more quickly than any alternative.”

IMF Managing Director Dominique Strauss-Kahn told euro-area finance ministers on Dec. 6 that they should disburse aid preemptively instead of waiting for a last-ditch request as happened with Ireland, an official familiar with the debate said yesterday.

In a side battle with a onetime ally, Merkel is also trying to muzzle proposals by Juncker for joint euro-region bond sales to create a more liquid market.

Juncker, head of the panel of euro-area finance ministers, called for European governments to pool borrowing for debt up to 40 percent of gross domestic product.

To provide an incentive to keep debt down, each country would have to finance borrowing above that limit on its own, incurring penalty interest rates, Juncker and Italian Finance Minister Giulio Tremonti proposed last week.

Merkel reiterated her opposition to euro-area bonds today, saying they “are not the answer” to Europe’s debt challenges.

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