ECB Says It May Buy Bonds If Strict Conditionality Ensured

The European Central Bank said it may intervene in bond markets in tandem with Europe’s bailout funds if troubled nations commit to improving their economies and fiscal positions.

“The adherence of governments to their commitments and the fulfilment by the European Financial Stability Facility/European Stability Mechanism of their role are necessary conditions,” the Frankfurt-based ECB said in its monthly bulletin today, echoing President Mario Draghi’s remarks on Aug. 2. The central bank “may undertake outright open market operations of a size adequate to reach its objective.”

The ECB is stepping up its crisis response after Spanish and Italian bond yields surged, exacerbating a sovereign debt crisis that has forced five of the 17-euro members into seeking external aid. Draghi last week justified any potential intervention, saying rising borrowing costs in “several countries and financial fragmentation hinders the effective working of monetary policy.”

Still, “in order to create the fundamental conditions for such risk premia to disappear, policy makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination,” the ECB said. “Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist -- with strict and effective conditionality.”

Market Tensions

A further worsening of the crisis is likely to hurt economic growth in the euro area, “with the ongoing tensions in financial markets and heightened uncertainty weighing on confidence and sentiment,” the report said.

Today’s bulletin also contains the quarterly survey of professional forecasters. Their estimate for 2012 inflation remained unchanged at 2.3 percent. For 2013, they expect annual price gains to average 1.7 percent, down from 1.8 percent previously estimated, and for 2014 they predict 1.9 percent. The longer term inflation forecast remained at 2 percent.

On growth, the forecasters predict a 0.3 percent contraction for 2012, down from a 0.2 percent contraction expected last quarter. For 2013, they anticipate growth of 0.6 percent, down from a previous estimate of 1 percent. For 2014, they see the economy expanding 1.4 percent.

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