European Central Bank President Mario Draghi last week fueled expectations that the central bank would adopt some bold measures to tackle the eurozone crisis, but the room for disappointment has widened as the time approaches.
The central bank to the 17 nations that use the euro as common currency is likely to leave its benchmark interest rate, known as the refi, at its record low of 0.75 percent on Thursday. Last month, the bank cut the rate by a quarter-point, the third reduction since Draghi took over as the ECB chief in November.
The cut took the refi rate below 1 percent for the first time in ECB's history. The central bank also lowered its deposit rate by 25 basis points to zero.
Spain and Italy have been struggling with rising borrowing costs in recent weeks. Investors were concerned that Spain would be forced to seek a bailout for it entire economy and not just its banking system, after it emerged at least six of the 17 regions of the country were likely to seek financial assistance from the government.
Draghi pledged last Thursday that "Within our mandate, ECB is ready to do whatever it takes to defend the euro". And that will be enough, he added. Germany, France and Italy have also voiced their support of protecting the euro.
Yet, economists are doubtful that ECB would announce any drastic measures. "Any action to substantially tackle the debt crisis would come with a high risk of inviting political complacency and moral hazard," ING Bank Economist Carsten Brzeski said.
Markets took some comfort from Draghi's comments and the struggling Spain and Italy saw their bond yields ease at the start of this week. However, the optimism soon dimmed, after dampening comments from Germany.
Bundesbank President Jens Weidmann, who is a strong critic of ECB's bond purchases, said in an interview published on Wednesday that the ECB must not exceed its mandate to fight inflation.
Draghi's assurance last Thursday is seen as a signal that the ECB may consider resuming purchases of government bonds. The ECB bond-buying scheme known as the Securities Market Programme was suspended in March. It is also speculated that the bank would propose that the eurozone permanent bailout fund, the ESM, must be allowed to buy bonds of troubled euro nations.
"If the Bank's plans amount to no more than a reactivation of its dormant Securities Market Programme (SMP), we suspect investors will be unimpressed on Thursday," Capital Economics Economist John Higgins said.
"A greater sense of calm might be restored if EU leaders were willing to grant the ESM a banking licence, so that the rescue fund could leverage its resources adequately to bail out Spain and Italy."
ECB Governing Council Member Ewald Nowotny said on July 25 that there are arguments in favor of providing a banking license to the eurozone's permanent bailout fund, the European Stability Mechanism. A banking license will give the ESM an access to ECB lending.
The German Federal Constitutional Court is set to decide on September 12 whether the country's ratification of EU's fiscal pact on budgetary discipline and the ESM is constitutional or not.
With the ESM activation and the troika assessment of Greece pending, ideally eurozone politicians would like to postpone all next crucial issues and decisions until the second half of September, ING's Brzeski said.
He expects the ECB to adopt a minimalist approach on Thursday with a bit of SMP and maybe a little of more tailor-made credit stimulus, long-term refinancing operations (LTRO) and possibly even a rate cut.
The ECB is set to announce its interest rate decision at 7.45 am ET on August 2. ECB President Draghi will begin the regular post-decision press conference at 8.30 am ET.
by RTT Staff Writer
For comments and feedback: email@example.com