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Draghi’s Mixed Bag Does Not Include Monetary Financing

Euro zone markets dipped after European Central Bank president Mario Draghi’s announced a mixed-bag of proposals to calm the euro zone crisis, but fell short of monetary financing.

Mario Draghi fired the full range of weapons in the European Central Bank’s arsenal on Thursday in a bid to prevent the euro zone crisis from turning into a catastrophe. But he disappointed financial markets by rejecting radical proposals to support ailing euro zone sovereign bonds.

The president of the euro zone’s central bank announced a plethora of unconventional emergency measures to stabilize the 17-member bloc’s financial system. The most eye-catching is a widening of the range of securities which banks can use to borrow money off the ECB, which will make it easier for them to stay solvent by allowing them to depend more on the central bank.

The ECB also decided on Thursday to cut its main interest rate by another 25 basis points (bp) to 1 percent – repeating November’s reduction.

But although Draghi attempted to calm financial markets by describing a breakup of the euro zone as “quite farfetched,” investors were dismayed by his repeated refusal to consider monetary financing: bringing down unsustainably high euro zone government bond yields by creating money to fund massive ECB purchases of sovereign debt. Many analysts had hoped Draghi might cede ground on this issue, as a quid pro quo for national governments’ recent attempts to reduce yields through fiscal austerity.

The markets were also hit by signs from Draghi that the ECB may not cut its main interest rate any further to boost economic growth. Speaking at a press conference in Frankfurt following the interest rate decision, Draghi said the decision to trim the cost of borrowing by 25 basis points had not been unanimous. He added that “we didn’t discuss” a 50 basis point cut—a possibility mooted by private-sector economists before the meeting, given the dramatic downturn in euro zone growth prospects. He downplayed expectations of further rate cuts still more by declaring that “at the present time we don’t see any high probability of deflation.”

Draghi used the press conference to argue repeatedly that monetary financing was against the rules of the EU Treaty that governs the ECB. He also adopted an uncompromising posture towards various recent suggestions aimed at allowing the bank to get around the rules without technically breaking them. These included the idea that the ECB could indirectly finance euro zone governments by lending money to the International Monetary Fund, which would then use it to buy euro zone government bonds. He justified his strict stance towards such suggestions by saying: “We shouldn’t try to circumvent the spirit of the treaty.”

However, there was a warm welcome for Draghi’s decision to widen banks’ permitted collateral with the ECB. They will for the first time be able to use loans to small and mid-sized companies, for example. The ECB also decided on Thursday to prevent a freezing up of banks’ liquidity by offering them unlimited financing for a three-year period.

Although he poured cold water on various radical suggestions to solve the debt crisis through the ECB, Draghi argued that progress was being made in resolving debt burdens at a national level, in a press conference marked by the Italian central banker’s trademark elegant English and dry wit. He praised his home country’s recent austerity measures. He insisted that national governments had to address the root causes of the euro zone debt crisis by reducing their deficits, but added that “national economic policies are gradually falling into place.”

Draghi could prove a key player in the coming days, in talks by EU heads of state aimed at hammering out an accord to resolve the euro zone debt problem. When asked how he rated the chances of a Franco-German agreement to ease the debt imbroglio at the EU summit that began in Brussels on Thursday, he tried to sound positive but fell short of offering any assurances, saying: “I’m very optimistic of course, because I want to see something in place.” France would like the ECB to have greater powers to intervene in debt markets, but Germany has resisted this idea.

Euro zone financial markets were hit by Draghi’s comments—though losses were limited by continuing hopes for a political agreement at the Brussels summit. The Eurofirst 300 index of euro zone stocks was down 1.5 percent to 973.62, and the euro was 0.7 percent lower on the day against the dollar at $1.332, in late European trading. Yields on Italian 10-year debt—which has become a bellwether for the severity of the euro zone debt crisis—leapt 37 points to 6.92 percent. However, they remained just below the 7 percent mark, above which analysts say yields risk escalating rapidly upwards.

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