Monday, August 8, 2011

The reluctant rescuer

August 8, 2011

Once again, as the euro area appeared to teeter at the edge of an abyss, a sharp tug from the central bank has restored a margin of safety, albeit a slim one. In May 2010, as markets were panicking about Greece, it was the decision by the European Central Bank (ECB) based in Frankfurt to start buying Greek government bonds in the markets that calmed nerves as much as the euro-area governments’ decision to create a new bail-out fund, the European Financial Stability Facility (EFSF). This week, the ECB has pulled off the same trick by deciding to purchase Italian and Spanish government bonds at an emergency weekend conference-call meeting of its 23-strong governing council.

The move was prompted by market pressures building on the much bigger economies of Italy and Spain, as yields on their debt threatened to reach unsustainably high levels. The jitters were all the more remarkable given that an emergency summit of European leaders on July 21st to agree upon a second rescue for Greece had also sought to reduce the risk of sovereign-debt worries spreading to other vulnerable countries by expanding the role of the EFSF, allowing it to intervene in secondary markets as well as to extend lines of credit to such economies.

The trouble is that the bail-out fund will not be able to do this until its new remit is ratified by the 17 euro-area governments this autumn. Even an emergency return by leaders from their (wrecked) summer holidays would not help unless parliaments were recalled, too; and that might stoke even greater alarm. In any case, the package due to be ratified failed to boost the size of the fund beyond the already agreed target of an effective lending capacity of €440 billion ($620 billion). That is enough to finance the rescues of Ireland and Portugal and the second bail-out of Greece, but would be insufficient to deal with Italy, let alone Italy and Spain.


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