ECB holds off to force politicians' hand in crisis

FILE - In this May 31, 2012 file picture President of the European Central Bank Mario Draghi reports to the Economic Committee, in capacity as the head of the European Systemic Risk Board, at the European Parliament in Brussels. The European central Bank's 23-member governing council meets Wednesday June 6, 2012. No cut is expected in its benchmark interest rate, which has already been lowered to a record low 1 percent. Draghi wants politicians such as Germany?s Chancellor Angela Merkel, French President Francois Hollande and European Commmission President Jose Manuel Barroso to come together on far-reaching and potentially controversial action to fix what?s really wrong with the euro at a summit June 28-29 in Brussels. Then, analysts say, more help might be forthcoming. (AP Photo/Yves Logghe)

FILE - In this May 31, 2012 file picture President of the European Central Bank Mario Draghi reports to the Economic Committee, in capacity as the head of the European Systemic Risk Board, at the European Parliament in Brussels. The European central Bank's 23-member governing council meets Wednesday June 6, 2012. No cut is expected in its benchmark interest rate, which has already been lowered to a record low 1 percent. Draghi wants politicians such as Germany?s Chancellor Angela Merkel, French President Francois Hollande and European Commmission President Jose Manuel Barroso to come together on far-reaching and potentially controversial action to fix what?s really wrong with the euro at a summit June 28-29 in Brussels. Then, analysts say, more help might be forthcoming. (AP Photo/Yves Logghe)

President of the European Central Bank Mario Draghi reports to the Economic Committee, in capacity as the head of the European Systemic Risk Board, at the European Parliament in Brussels, Thursday, May 31, 2012. (AP Photo/Yves Logghe)

President of the European Central Bank Mario Draghi drinks as he reports to the Economic Committee, in capacity as the head of the European Systemic Risk Board, at the European Parliament in Brussels, Thursday, May 31, 2012. (AP Photo/Yves Logghe)

FRANKFURT, Germany (AP) ? The European Central Bank has a powerful weapon that just might push political leaders into solving the continent's financial crisis once and for all: withholding further help.

The ECB isn't likely to take any new steps when it meets Wednesday, analysts say, even as anxiety builds over the deteriorating outlook for Europe's economy and banking system.

ECB President Mario Draghi signaled last week that he wants to see stronger political and financial ties among the 17 countries that use the euro. If such ties are agreed to ? possibly at a European Union summit later this month ? analysts say the ECB would be much more likely to reward European governments and banks with the financial shot in the arm that they desperately need.

No cut is expected in the ECB's benchmark interest rate Wednesday, which has already at a record low of 1 percent. And there's little prospect that it will serve up more cheap emergency credit for shaky banks, after it already has handed out ?1 trillion ($1.24 trillion) in December and February.

It's a risky game because the eurozone ? the 17 countries that use the euro as their currency ? is in big trouble. Investors have turned their focus on Spain amid concerns that it will not be able to find enough money to prop up its struggling banking sector. This has pushed the country's borrowing costs on the bond markets to worrying heights, making it harder to keep paying its debts as they come due. There are concerns that Spain may join Ireland, Greece and Portugal in seeking international assistance. However, because Spain's economy is so much larger than the other three, any bailout would seriously strain other countries' resources.

The eurozone's banks have also been a key part of Europe's government debt crisis. Bailing out the banks is a huge burden on financially shaky governments, and weak government finances in turn hurt the banks that hold those governments' bonds. Most powers to regulate banks have been left with national authorities, who have been seen as protective of their domestic financial services industries at the detriment of Europe's banking sector.

And in just over two weeks, Greece returns to the polls with a real danger looming that it might elect a government that rejects the terms of its multi-billion-euro bailout. This could force the country out of the euro, irreparably fracturing the eurozone and further roiling markets.

A Spanish default, banking collapse, or a Greek euro exit, could spread financial shock waves and shove the global economy into another recession. The world's markets have fallen on fears that this is around the corner.

Over the past week there has been a concerted push by some of Europe's leading authorities to get the region's leaders to act ? and quickly. Last Wednesday, the European Union's executive body, the European Commission, called on politicians to work on founding a central authority with the financial muscle to fix its broken banks. The very next day, Draghi laid down a forceful challenge to politicians, describing the current setup of the 17-country currency union "unsustainable" and calling for a clear vision for reworking the foundations in place since its launch in 1999.

"Dispel this fog," he urged members of the European Parliament in Brussels.

Analysts say the ECB has a strong motive for staying put until it sees some movement from governments.

"The ECB looks tired of being the eurozone's fire brigade and seems to have a preference for staying on hold," Carsten Brzeski, an analyst at ING in Brussels, wrote in a note to investors. "It looks like the ECB will want to keep the pressure as high as possible to tackle political complacency."

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.

Associated Press

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