Draghi’s Hands May Be Tied on Stimulus After Stark Resigns

Financial Stability Board Chairman Mario Draghi
Mario Draghi, chairman of the Financial Stability Board (FSB) and governor of Italy's central bank. Photographer: Antoine Antoniol/Bloomberg

Mario Draghi may find it harder to keep the European Central Bank in the vanguard of the battle against the euro region’s debt crisis after Juergen Stark resigned in protest at the bank’s bond purchases.

With speculation of a Greek default heaping pressure on the ECB to step up its bond buying and reverse interest-rate increases to ease market tensions, Stark’s shock move has publicly exposed a rift among policy makers that may undermine its ability to act quickly, economists said. German opposition to further ECB stimulus may also make Draghi less inclined to ease policy when he takes over from ECB President Jean-Claude Trichet on Nov. 1, said Marco Valli, chief euro-area economist at UniCredit Group in Milan.

“It would be very easy for Germans to say here comes the Italian, he’ll cut rates and buy government bonds in massive amounts,” Valli said. Draghi “will probably prefer to err on the side of hawkishness on standard measures, which means he may be reluctant to go for a rate cut.”

The ECB has shouldered the main burden of fighting the crisis as governments dithered over fixing their budget deficits, restructuring their banks and giving more firepower to the region’s rescue fund. Investors last week dumped stocks and pushed the euro to a six-month low on renewed fears that policy makers will fail to prevent a Greek default. Stark’s resignation on Sept. 9 further unsettled markets by raising doubts about the ECB’s commitment to do what’s needed to hold the 17-nation euro zone together.

Anchor of Stability?

“It’s bad news because the ECB is the only functioning European institution, it’s supposed to be an anchor of stability,” said Laurent Bilke, a former ECB economist now working at Nomura International in London. “For the central bank to be functioning in its role, its interventions need to be forceful. This whole affair will put them and any decision they make under the spotlight.”

Stark, a former Bundesbank vice president, cited “personal reasons” for his decision and will remain in his role as the ECB’s chief economist until a replacement is found for him on the six-member Executive Board. German Finance Minister Wolfgang Schaeuble said Sept. 10 he will propose his deputy, Joerg Asmussen, for the job.

German Opposition

Bundesbank President Jens Weidmann also opposed the ECB’s decision to reactivate its bond-purchase program last month, when it started buying Italian and Spanish assets after the debt crisis spread, an official familiar with the discussions said.

Asmussen and Weidmann were both economics students of Axel Weber, the former Bundesbank president whose opposition to the ECB’s bond program led him to resign in February and drop out of the running to succeed Trichet.

“This is the second resignation in less than a year, this is clearly not good news,” said Klaus Baader, co-head of euro-area economic research at Societe Generale in London. “This will raise doubts about the real commitment of Germany to the ECB, and that is why it’s highly damaging.”

Stark’s resignation may harden German public opinion against the region’s rescue fund, making it harder for governments to fight the crisis, said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. It “makes the European bailout scheme more unpopular among German voters, which lowers the long-term credibility of the bailout policy among investors,” he said.

Rescue Fund

Fifty-three percent of Germans oppose further aid for Greece and would not save the country from default if it doesn’t fulfil the terms of a rescue, Bild am Sonntag newspaper reported yesterday, citing a poll.

While European leaders have agreed to retool the region’s 440 billion-euro ($602 billion) rescue fund -- the European Financial Stability Facility -- to take over government bond purchases from the ECB, the proposal has to be ratified by national parliaments first.

Stark’s resignation “shows why the ECB is so desperate for the EFSF to take over the bond purchases,” said Julian Callow, chief European economist at Barclays Capital in London. “The division over bond purchases goes right to the heart of the ECB, with the triple A-rated countries opposing it.”

Trichet said today at a press briefing in Basel that he respects Stark’s reasons for resigning. “We are one central bank, one Governing Council,” he said. “We have a great level of credibility that we will preserve in all circumstances, as we have done since the start of this crisis.”

Blurred Line

Stark expressed his strong opposition to buy more distressed assets on an ECB conference call on Sept. 4 and was backed by the central banks of Austria and the Netherlands, according to a central bank official familiar with the meeting.

The ECB, which started its bond program in May last year when Greece’s fiscal crisis began to spread to other euro-area countries, has so far spent 129 billion euros on the secondary market in an attempt to lower yields. The ECB says it is trying to ensure the transmission of its interest rates.

Stark told Bloomberg News on Aug. 18 that the purchases also mean the ECB is lowering borrowing costs for distressed governments, blurring the line between monetary and fiscal policy. Weidmann on Sept. 1 urged the ECB to “scale back the extra risk monetary policy has taken on.”

“Although the Bundesbank does not technically have a veto at the ECB, you do wonder how far along this path the ECB can go with Germany and the Bundesbank so adamantly against it,” said Nick Kounis, head of macro research at ABN Amro in Amsterdam. “Following Stark’s resignation, the credibility of the ECB intervening in a sustained way over time has clearly been hit.”

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