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ECB holds off to force politicians' hand in crisis

By David Mchugh

Associated Press

Published: Tuesday, June 5 2012 11:51 a.m. MDT

However, the eurozone's problems could always force the ECB's hand. The region's economy could well shrink by more than the mild 0.3 percent predicted by EU forecasters. Key surveys of business confidence are pointing down. A shrinking economy lowers tax revenue and makes it harder for governments to pay their debts. This economic slide puts the ECB under pressure to act quicker than it would like. This puts the ECB and Draghi in a predicament somewhat like that of the U.S. Federal Reserve and Ben Bernanke. Poor hiring statistics on Friday have raised the possibility of more action by the Fed, which has cut interest rates to near zero but could do another round of bond purchases, a step which increases the supply of money.

If Draghi and the governing council see results from Europe's leaders at the June summit, they might be inclined to respond with more help. That's what the ECB did after the fiscal treaty was agreed in December — following up with the cheap bank loans that help hold the crisis at bay temporarily.

Among the measures the ECB could introduce are:

— Cut interest rates below its current record of 1 percent. Analysts say they could go as low as 0.5 percent. The ECB might be forced to do that as early as July if the economy keeps deteriorating or there's a default or other disaster. Lower rates can help growth by lowering borrowing costs for businesses. But it is unlikely to act this week.

— Offer more cheap long-term loans to banks. The first two rounds helped ease the crisis by letting troubled banks borrow at a current rate of 1 percent for three years. It's a powerful weapon but carries risks of political complacency and losses on the loans.

— Direct purchases of government bonds. This would push the price of government bonds up and government borrowing costs down. The ECB did this intermittently to support Spain and Italy until late last year. But the limited nature of the program did not impress bond markets much.

But for the ECB to introduce these measures, it needs action from Europe's leaders. Among the options open to the region's politicians are:

— Plans for an EU-wide bank regulator and bailout fund with powers to take over and restructure banks, whose financial troubles are a key burden for governments. Spain's Prime Minister, Mariano Rajoy, and a number of economists have proposed letting the eurozone's current bailout fund put money directly into banks.

— Some form of common debt designed to reduce the chance of default by any one country. Italy and France have called for these so-called eurobonds in which eurozone countries would guarantee each other's repayments. However, Germany, the eurozone's biggest country and chief contributor to bailouts, is resisting, afraid that spendthrift governments will freeload on its strong credit rating.

— More control at the EU level over what countries spend, a step that could ease German fears about shared bonds. There's already a new treaty limiting debt, signed but not yet ratified.

The reforms are tough to accomplish politically because they often mean richer, better run countries — such as Germany — taking on some of the risk for bad behavior by other countries that don't manage their economies or finances well. Or it means governments giving up control over banks or finances. And most would take years to implement. Still, quick decision-making by governments could reassure the markets and help the eurozone step back from the edge.

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