FRANKFURT (MNI) – European Central Bank President Jean-Claude
Trichet sharpened his tone over the weekend, warning governments against
letting Greece default just days ahead of the emergency summit at which
Eurozone heads of state and government may decide to do just that.

“If a country defaults, we can no longer accept as normal eligible
collateral defaulted bonds issued by the government of that country,”
Trichet said in an interview with Financial Times Deutschland. “The
responsibility for this lies with the governments. The governments have
been warned, in no uncertain terms and using all possible means.”

Should governments go ahead with restructuring plan, they will have
to provide a solution to keep Greek banks alive, Trichet said. In
effect, this may mean that governments will have to inject so much fresh
capital into Greek banks that a large chunk of any private sector
contribution would be eaten up rendering the deal financially useless.

German chancellor Angela Merkel continues to insist that private
sector involvement must be part of a new deal for saving Greece. While
she said she hopes to avoid a default scenario, rating agencies have
warned that plans floated thus far would all lead to selective default.

In another sign of hardening fronts, one of the ECB’s most
outspoken critics of any form of Greek debt restructuring, let alone a
Eurozone breakup, appeared for the first time to allow for the
possibility that Greece could actually leave the Eurozone if it is
unable to address its problems effectively.

Asked whether he was worried about the viability of the euro as a
currency, Bini Smaghi said: “The Greeks for example want to stay in the
euro, but for this to happen they have to put their house in order. They
have to face reality.”

Instead of a private sector contribution that would lead to
default, the ECB is pushing for an expanded role of the European
Financial Stability Facility (EFSF), which would allow it to buy
government debt in the secondary market.

Trichet, Bini Smaghi and Yves Mersch over the weekend all called
for stepping up flexibility of the fund to include the possibility of
secondary bond market intervention.

“This would allow the private sector to sell bonds at their market
value which is currently lower than the nominal value,” Bini Smaghi
said. “This would allow the private sector to sell while the public
sector would save money. But such an option was not included in the
design of the EFSF. If there is a way to change the EFSF, that would be
useful.”

Trichet said that instead of coming up with new tools, such as
Eurobonds, “what counts now is that we make optimal use of the
instruments at our disposal.” In particular, “the European Financial
Stability Facility (EFSF) should be used as flexibly and effectively as
it possibly can be,” he asserted, using code language that essentially
means it should be allowed to buy bonds.

At last week’s Eurogroup meeting, finance ministers said they had
decided to enhance “the flexibility and the scope of the EFSF.” However,
their statement did not specify whether this flexibility would include
the ability to buy bonds on the secondary market.

In another sign that the ECB is no longer ready to offer central
bank support where its deems fiscal support warranted, Mersch indicated
that the ECB has not resumed its bond buys as markets had speculated
last week. With the EFSF in place “we can consequently defend the strict
distinction between monetary and fiscal policy,” Mersch said.

Trichet said that the ECB will not do anything that would impair
its “ability to be an anchor of confidence and stability” — words
echoed by Mersch, who said the central bank will focus instead on its
main mandate of delivering price stability.

In order to do so, further rate hikes may be warranteed, Mersch
hinted.

While he said that the ECB had not announced “a series of rate
hikes” and is “never pre-committed,” he also observed that “risks to
growth are balanced, while risks to price stability lie on the upside,”
and the monetary pillar show no credit constraints.

At the same time, real interest rates are still negative, Mersch
observed. “The whole available theory tells us about the danger of
too-long periods of negative real rates. This is also an argument and we
discuss it at every meeting in order to reach our goal of price
stability in the medium term.”

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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