FRANKFURT (MNI) – European Central Bank President Mario Draghi on
Thursday hinted that the ECB may step up its crisis response in return
for new political commitments from national governments, and he
bolstered expectations for interest rate cuts and additional liquidity

Speaking in the European Parliament, Draghi said the Eurozone needs
first and foremost stricter fiscal governance rules to restore
confidence, after whick “other elements might follow.”

The Eurozone needs “a new fiscal compact – a fundamental
restatement of the fiscal rules together with the mutual fiscal
commitments that euro area governments have made,” Draghi said.

Such a fiscal compact is “definitely the most important element to
start restoring credibility,” he said. He dismissed possible criticism
that such long-term measures may not address short-term pressures.

“Confidence works backwards: if there is an anchor in the long
term, it is easier to maintain trust in the short term,” Draghi argued.

Still, he appeared to recognize that additional moves to address
short-term tensions may be needed, noting that progress on improving
fiscal rules, both at national and Eurozone levels, had failed to calm
financial markets.

“Other elements might follow, but the sequencing matters,” Draghi

While he also repeated that the ECB can only act within its mandate
under the EU treaty, his comments nonetheless suggest that the central
bank may be willing to ratchet up its crisis fighting measures should
governments offer stronger commitments at next week’s EU summit.

The ECB will want to see an accord on much tougher fiscal rules and
means of enforcement, including a possible surrender of national fiscal
sovereignty. Germany has pushed for an agreement on treaty changes that
would allow the union to veto national budgets likely to violate
Maastricht criteria.

Well-placed Eurosystem sources recently told MNI that many ECB
policy-makers are indeed more flexible on further ECB interventions than
recent rhetoric suggests, but that additional political commmitments
would be required first.

The chances of a grand deal — similar to the one seen in May 2010
— appear to be rising. Eighteen months ago, with the Greek crisis
threatening to spill over to the rest of the Eurozone, the ECB dropped
its previous stance against buying sovereign bonds and launched its
Securities Market Programme (SMP), after extracting a multi-year
commitment to fiscal discipline from political authorities.

One option that appears to be gaining traction recently is to boost
the International Monetary Fund’s resources, possibly by having national
Eurosystem central banks ratchet up their provisions to the Fund, which
would then lend the money to Eurozone governments in need.

A more direct option that has been discussed would be for the ECB
to step up its bond buys in a significant way. It could simply purchase
in much larger volumes without quantitative objectives, or it could
target specific yields, or it could seek to prevent spreads between the
yields of different Eurozone Bonds from widening beyond a specified

Strong resistance from the usual quarters, however, means that
conditions may still have to get worse before the ECB commits to such
direct, higher-octane intervention, one well-placed Eurosystem source
told MNI.

More immediately, the ECB appears ready to ease recent market
tensions by cutting interest rates and injecting fresh liquidity,
Draghi’s comments in parliament suggest.

“The ECB’s monetary policy is constantly guided by the goal of
maintaining price stability in the euro area over the medium term. And
when I say this, I mean price stability in either direction,” Draghi
said. He also pointed to downside risks to the economic outlook and its
moderating impact on price pressures.

Draghi said that none of his comments should be interpreted as a
signal for future monetary policy, since the ECB is in the blackout
period with the next monetary policy meeting just a week away.
Nevertheless, his comments seem to justify market expectation of further
interest rate cuts in the near-term.

The ECB President also enhanced the credibility of recent leaks
about plans for additional liquidity support measures, including
possible refinancing operations with maturities of two or three years,
and a wider collateral framework.

Draghi warned that the ECB had “observed serious credit tightening
in the most recent period.” He also stressed that the ECB is “aware of
the continuing difficulties for banks due to the stress on sovereign
bonds, the tightness of funding markets and scarcity of eligible
collateral in some financial segments.”

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