Central bank takes center stage in EU debt crisis

By Pan Pylas

Associated Press

Published: Thursday, Dec. 2 2010 12:00 a.m. MST

LONDON — The European Central Bank appears set to keep its special measures to flood banks with cash and could even step up purchases of government bonds to help countries contain a debt crisis that threatens to spiral out of control even after last weekend's bailout of Ireland.

A new boost for the European economy from Thursday's ECB meeting would be a far cry from what was planned just a week or two ago — and certainly was not on the agenda at last month's gathering.

Expectations the bank will step up its efforts, while keeping its benchmark interest rate unchanged at the record low of 1 percent, are one sign of how quickly the debt crisis has sharpened worries that a financially weak member of the eurozone such as Portugal might join Greece and Ireland in needing a bailout — and, even more dangerous, that larger countries such as Spain might run into trouble as well.

After last month's policy meeting, Trichet gave every indication that the central bank was looking at calling time on several props for the financial system introduced since the crisis took hold in August 2007.

Since Trichet's last post-meeting press conference on Nov. 4, the markets have dealt the 16-country eurozone a series of blows that have once again called into question the future of the euro currency itself.

The market pressure grew more and more acute on Ireland, eventually forcing its embattled government to follow Greece and request a multibillion bailout from its partners in Europe and the International Monetary Fund.

The response to its €67 billion ($89 billion) bailout has been lukewarm at best as investors fret about the possibility that other countries will get dragged into the bond market mire and find themselves unable to borrow in the money markets. Portugal is most people's candidate to be the next potential bailout recipient. Its borrowing rates have risen sharply in recent weeks, though a bond sale on Wednesday went better than expected, easing some immediate pressure on the country's markets.

The real fear in the markets is that larger countries like Spain could become destabilized.

Most analysts think European authorities can handle bailing out the relative minnows of Greece, Ireland and Portugal, but Spain — at around 12 percent of the euro-zone economy — would be different matter altogether.

It's this worry primarily that has hit the euro hard over recent days.

On Tuesday, it sank to $1.2968, its lowest since mid-September. At last month's meeting, the euro was trading at a ten-month high of $1.4281 and all the talk in the markets was that the U.S. and China were weakening their currencies — anyone remember talk of a currency war? — squeezing up the value of the euro, to the potential detriment of Europe's exporters.

The hope, at least among those who think that the markets are currently massively overreacting by selling off government bonds, is that the ECB can instill some confidence, or at least some sense of balance. The ECB effort to buy bonds would support prices, and drive down yields — the borrowing costs that governments would face next time they tap the bond market to roll over their debt loads. Excessive yields can effectively cut off a country from borrowing, leaving it staring default in the face unless it gets a bailout.

"The hope would be that the ECB will fill the role of air-traffic controller, talking the market down to a soft landing," said Daragh Maher, an analyst at Credit Agricole.

As a result, there are expectations that the ECB will refrain from discontinuing special liquidity measures for banks and may actually announce additional liquidity support over a longer period.

Olli Rehn, the EU's monetary affairs commissioner, hinted Wednesday that the ECB is poised to announce fresh measures following its meeting.

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