Thursday, July 26, 2012

Update On Europe ... Central Bank Will Defend Euro

The European Central Bank head today announced the ECB will defend the euro currency to the hilt and that it won't break up anytime soon.

While that's a good thing, it won't solve any competitiveness issues or growth needs for the various European economies.

What it will do, however,  is limit interest rate increases and give countries a chance to do something meaningful about their debt and economic growth problems. That's only an interim and temporary band-aid solution. It won't change the cultures or financial condition of welfare states such as Spain, Italy and Greece, among others.

ECB's Draghi Reiterates Euro Support says this:

"European Central Bank President Mario Draghi on Thursday delivered a pointed reminder that the central bank stands ready to protect the euro if required, providing an indication that the ECB is concerned about elevated borrowing costs in Spain and Italy.

"We think the euro is irreversible. And it is not empty words now. The actions we are making would make it irreversible," Mr. Draghi said at a conference of businessmen and politicians in London.

Financial markets took his remarks as a sign that the central bank may be ready to buy government bonds or embark on other measures to drive sovereign borrowing costs down as long as its actions remain within its mandate, but that it won't embark on another long-term refinancing operation or quantitative easing despite market pressure.

The ECB is concerned that rising risk premia—the extra money investors demand for being willing to finance financially weak governments such as Spain and Italy—are becoming an obstacle for the bank's record low interest rates to reach the wider economy, the central bank governor noted.

"To the extent the size of this sovereign premia hamper the functioning of the monetary policy transmission channels, they come within our remit. So we have to cope with this financial fragmentation by addressing these issues," Mr. Draghi said. . . .

Mr. Draghi's comments may indicate the ECB's willingness to restart bond purchases as Spanish government bond yields have hit all-time highs recently and Italy is facing contagion from that. Or he could be indicating that some other measures are in the pipeline.

The ECB is ready to do whatever it takes to preserve the euro but will remain within its mandate and not substitute government action with its steps, Mr. Draghi added, speaking a week before the central bank's policy-setting governing council meets.

Mr. Draghi stressed that the ECB isn't willing to abandon its mandate of guarding price stability, which it defines as an inflation rate of less than but close to 2%.

"Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough," Mr. Draghi said.

"The problem is we want to do it within our mandate, that is what makes the thing both effective and right. We don't want to supplement actions that have to be taken by governments, we can't supplement actions that need to be taken at the euro level—that is not our job. Our job is to maintain price stability and to handle the fragmentation of the markets," Mr. Draghi said."

My Take

This breaking news is a good adder to our previous post today about Europe's financial woes.

It may buy some time for governments to address their existential financial issues, but it by no means will solve them.

While monetary policy is helpful, a country's fiscal policy is even more important, and the economic growth of a country's private sector is the most important factor.

That said, this morning's ECB announcement is an assist, albeit not a solution of any kind.

We'll get into the competitiveness and private sector growth issues later.

Thanks. Bob.

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