Draghi Pushes to Unfreeze Credit Markets, Damps Bond Talk

Mario Draghi
Mario Draghi, president of the European Central Bank (ECB), speaks during the Banking Congress in Frankfurt, Germany. Photographer: Hannelore Foerster/Bloomberg

European Central Bank President Mario Draghi cut interest rates and offered banks unlimited cash for three years while damping speculation the ECB will buy more government bonds to stem the region’s debt crisis.

Policy makers meeting in Frankfurt today reduced the benchmark rate by a quarter percentage point to 1 percent, matching a record low. They also loosened collateral rules so that banks can borrow more from the ECB and announced two unlimited three-year loans. The measures “should ensure enhanced access of the banking sector to liquidity,” Draghi said at a press conference.

Hours before European leaders meet in Brussels, Draghi kept the onus on them to solve the two-year debt crisis by repeating his call for a “fiscal compact” and denying he had hinted the ECB would automatically support such an initiative with more bond purchases.

Draghi’s comments roiled markets, with stocks and the euro rising on the bank-lending measures before falling after he damped expectations of more ECB bond buying. The euro sank more than 1 percent and traded at $1.3310 at 6:30 p.m. in Frankfurt.

“All euro-area governments urgently need to do their utmost” to deliver fiscal sustainability, Draghi said. He denied his Dec. 1 remark that “other elements” could follow a push toward fiscal union was a signal the ECB could step up its bond-market intervention, saying he was “kind of surprised” it had been interpreted that way.

‘Explicitly Clear’

“The headline event today was that Draghi made it absolutely and explicitly clear that there would be no ECB bond buying bazooka,” said James Nixon, chief European economist at Societe Generale SA in London. “They’ll stay in the market but will only buy small amounts. It’s governments who’ll have to do the heavy lifting.”

The Stoxx Europe 600 Index declined 1.5 percent to 237.71 at the close of trading after earlier rallying as much as 1 percent. Italian and Spanish 10-year bond yields rose more than 20 basis points, climbing to 6.4 percent and 5.8 percent respectively.

Speaking at the same time in the French port of Marseille, German Chancellor Angela Merkel played down investor hopes by saying there will be no “big-bang” solution for Europe’s woes at the summit, which starts at 7:30 p.m. in Brussels. The meeting will be “one stop” along the way to ending them, she said.

Lending Jolt

With the ECB’s focus on jolting banks into lending, Draghi made it easier for them to borrow cash from the central bank.

Credit claims such as bank loans will become eligible as collateral and the central bank reduced the rating threshold on asset-backed securities.

The ECB also cut in half banks’ reserve ratio, which determines the amount of money they have to deposit with their national central banks every month, to 1 percent of total assets.

Reserve requirements currently amount to around 206 billion euros ($275 billion), so the reduction means “a significant increase in available collateral to banks,” said Laurent Fransolet, head of European fixed income strategy at Barclay’s Capital in London.

Draghi said the new measures should encourage banks to lend to companies and households.

Bank Capital

Europe’s banks will need to raise 114.7 billion euros in fresh capital as part of measures introduced in response to the euro area’s sovereign-debt crisis, according to documents from the region’s banking regulator obtained by Bloomberg News.

Draghi said that policy makers currently see “substantial downside risks to the economic outlook for the euro area” in an “environment of high uncertainty.”

Underscoring the weaker economic outlook, the ECB slashed its forecast for growth next year to 0.3 percent from 1.3 percent. Inflation will slow to 2 percent in 2012 and 1.5 percent in 2013 from 3 percent today, it predicted.

Draghi spoke as EU leaders meet to devise a fifth “comprehensive” solution in 19 months to a crisis that has left Germany and France, the euro’s linchpins, facing the threat of losing their AAA credit rating from Standard & Poor’s.

IMF Plan

Merkel and French President Nicolas Sarkozy are proposing to amend European treaties to tighten controls on budgets. Leaders are also mulling a plan that would channel central bank loans through the International Monetary Fund to fight the debt crisis. Draghi said this would violate the ECB’s founding treaty if “the IMF were to use this money exclusively to buy bonds in the euro area.”

The ECB is “saying no to almost everything,” said Holger Schmieding, chief economist at Berenberg Bank in London.

While offering maximum support for banks, the ECB “is refusing to address the root cause of the euro crisis, the collapse in global confidence in the ability of the euro zone to save itself,” he said. “That does not bode well for the further euro-zone decisions coming up in the next few days.”

-- With assistance from Jeff Black and Rainer Buergin in Frankfurt and Kristian Siedenburg in Vienna. Editors: John Fraher, Matthew Brockett