Draghi May Resist Stimulus Call Amid Risk of Greek Euro Exit

European Central Bank President Mario Draghi
European Central Bank (ECB) president Mario Draghi. Photographer: Hannelore Foerster/Bloomberg

Mario Draghi’s first act as European Central Bank President may be to remind investors he’s not there to bail out governments, even as Italian and Spanish bond yields soared after euro-area leaders raised the prospect of Greece exiting the monetary union.

As Europe’s debt crisis worsens, Draghi, who chairs his inaugural policy meeting in Frankfurt today, will resist pressure to increase the central bank’s commitment to buying the bonds of distressed euro states, economists said. The ECB will also keep its benchmark interest rate at 1.5 percent, according to 49 of 55 forecasts in a Bloomberg News survey.

The ECB has been asked to do more and more to stem Europe’s debt crisis, which reached new heights last night as France and Germany said they would treat Greece’s surprise referendum on a second bailout package as a vote on its euro membership. French President Nicolas Sarkozy said Greece won’t get a “single cent” of assistance if it rejects the plan. Italian bond yields surged to euro-era records on concern the crisis will engulf other highly-indebted nations in the 17-nation currency bloc.

“Don’t expect the ECB to bail everyone out,” said Marco Annunziata, chief economist at GE Capital in San Francisco and a former International Monetary Fund official. “It should not and it will not, unless it becomes a matter of life and death for the euro zone.”

G-20 Meeting

The ECB announces today’s rate decision at 1:45 p.m. and Draghi holds a press conference 45 minutes later. The U.S. Federal Reserve yesterday refrained from taking any additional policy steps while saying there are still “significant downside risks” to the economic outlook.

Three weeks after the Group of 20 told Europe to put an end to the debt woes that are roiling global financial markets, G-20 leaders meet in Cannes today with the crisis once again dominating the agenda.

On Oct. 27, Europe signed off on a new bailout package for Greece, including a 50 percent writedown on the nation’s debt, and an expanded rescue fund that the ECB expected to relieve it of its bond-buying duties.

Just a week later the deal is in limbo after Greek Prime Minister George Papandreou announced he will seek public support for the measures. Global stocks, the euro and the bonds of debt-strapped countries tumbled as concern of a disorderly Greek default mounted.

‘Yes or No?’

“The referendum will revolve around nothing less than the question: does Greece want to stay in the euro, yes or no?” German Chancellor Angela Merkel told reporters after crisis talks hours before the G-20 summit is due to begin in Cannes.

Papandreou, summoned to the French resort with his hold on power weakening at home and subject to a confidence vote tomorrow, defended his decision, saying Greece “needs a wider consensus” on the conditions attached to the bailout.

Italian 10-year bonds fell, driving the yield to as high as 6.39 percent, a euro-era record. The spread over benchmark German bunds widened to a record 462 basis points. Spain’s 10-year bond yield rose 10 basis points to 5.53 percent.

The ECB needs to “go into the market and say ‘We have a wall of money here and no matter how much speculation there is, we’re going to keep buying Italian bonds or any other euro bonds that are threatened’,” Irish Finance Minister Michael Noonan told Dublin-based RTE Radio yesterday.

Draghi, 64, has to try to forge consensus on a 23-member Governing Council already split over the ECB’s bond purchases, which now amount to 173.5 billion euros ($239.4 billion).

‘Printing Presses’

That’s likely to mean a continuation of the status quo, said Nick Matthews, an economist at Royal Bank of Scotland Group Plc in London, who expects Draghi to say merely that the bond purchases are “ongoing.”

Bundesbank President Jens Weidmann opposes the program and ECB Executive Board member Juergen Stark will step down at the end of the year over the issue. Council member Klaas Knot from Holland said yesterday that the ECB’s bond buying can’t be “unlimited” and should be stopped as soon as is feasible.

“Draghi is not going to crank up the printing presses after his first meeting, which is what the markets are essentially looking for,” said former ECB economist Tobias Blattner, now at Daiwa Capital Markets in London. “The most they can hope for is a rate cut in December, which is probably justified looking at the deteriorating economic outlook.”

Weaker Economy

With recent data signaling the euro region is edging toward a recession, six economists in the Bloomberg survey predict the ECB will cut rates today. Four expect a quarter-point reduction to 1.25 percent and two forecast a half-point move. Twenty of 32 economists in a separate survey expect a cut in December.

Unemployment in Germany, Europe’s largest economy, unexpectedly rose for the first time in more than two years in October and Europe’s manufacturing industry contracted for a third month.

While the current inflation rate of 3 percent is well above the ECB’s 2 percent limit, weaker growth and demand may drive down oil prices. The ECB currently forecasts inflation will slow to 1.7 percent in 2012.

The Organization for Economic Cooperation and Development on Oct. 31 lowered its growth forecast for the U.S. and the euro area. The U.S. economy, the world’s largest, will expand 1.7 percent this year and 1.8 percent next, the Paris-based OECD said. By contrast, the euro area’s will grow 1.6 percent in 2011 and just 0.3 percent in 2012, it said.

The state of the economy “may not be critical enough yet” to warrant a rate cut tomorrow, and the Bundesbank is “ardently opposed” to stepping up bond-market intervention, said Christian Schulz, senior economist at Joh. Berenberg Gossler & Co. in London.

“Draghi is likely to play it safe at his first press conference, making no new announcements or bold statements,” he said. “But it may not be long until the ECB will finally be forced to step in.”

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