European Central Bank to Shore Up the Euro

European Central Bank chief Mario Draghi has pledged full support for Europe’s single currency, boosting stock markets and easing pressure on Spanish borrowing costs.

The ECB is ready to do whatever it takes to preserve the Euro.  Keeping risk premiums under control was part of the central bank’s mandate as they affected the transmission channels for ECB policy. The interest rate, or yield, on 10-year Spanish bonds fell to 7.197 percent from 7.376 percent, a level that is nonetheless still considered unsustainable over the long term.

The comments by ECB president Mario Draghi look to have been the main catalyst sending the markets higher. In particular the comments about doing whatever it takes within the central bank’s mandate to preserve the Euro has seen markets rebound, but the statement that addressing high yields on sovereign debt in the euro area comes within the central bank’s mandate is particularly noteworthy. It suggests that the ECB may well do something about capping rising bond yields. Attention will now inevitably shift the focus towards next week’s ECB rate meeting to see if Mr Draghi means what he says.

Financial markets have relentlessly tested the Euro Zone’s ability to overcome debt crises in countries like Greece, Ireland, Portugal and Spain, and the ECB is the European Union institution most able to react quickly to developments. ECB responses to date include two cash injections of more than €1 Trillion in the Euro Zone banking system via long-term refinancing operations and the purchase of government bonds on secondary markets. The central bank has also cut its benchmark refinancing rate to a record low of 0.75 percent. Euro Zone leaders have agreed meanwhile on measures to help stem the crisis, and Mr Draghi stressed that progress has been extraordinary in the last six months.

But Europe’s current anti-crisis strategy is having only a limited effect and the central bank is the only player currently capable of acting fast enough. The bank could inject even more money into the banking sector, resume its purchases of government bonds on secondary markets, cut interest rates further, or come up with a way to provide Euro Zone financial rescue funds with more resources. Mr Draghi’s comments underpin recent remarks by ECB members such as Nowotny yesterday that the central bank could participate in beefing up current measures, such as increasing the firepower of ESM bailout funds, which would lead the ESM to have a banking license. He referred to the future Euro Zone rescue fund, the European Stability Mechanism.

This suggests the ECB is moving closer to undertake QE, which would be a much-needed shot in the arm for markets and go some way into forming the fiscal unity the euro-area desperately needs in order to arrest the debt crisis.

Article by AlgosysFx Forex Trading Solutions