PARIS (MNI) – The European Central Bank remains reluctant to buy
government bonds and is unlikely to embark on such a radical departure
from its current policy in the near future, well-placed Eurosystem
central banking sources told Market News International.

But the officials did not shut the door entirely on the idea, and
some conceded that the central bank might have to consider it more
seriously should the crisis in Greece worsen and threaten to inflict
significant losses on Eurozone banks that are holding large volumes of
Greek debt.

A split between those who more strongly oppose buying sovereign
debt of Eurozone states and others who think it may have to be
considered should the circumstances deteriorate indicates that it is
still a subject of debate on the Governing Council. ECB President
Jean-Claude Trichet left a question mark hanging over it when he said on
Sunday, “at this stage, we have absolutely no decision on the purchase
of government bonds.”

Several sources insisted that the ECB’s extraordinary decision to
drop minimum rating standards for collateral eligibility on Greek debt
was, despite much recent opinion to the contrary, completely consistent
with ECB’s ultimate mandate of preserving euro stability.

The original proposal on the table was to eliminate the minimum
rating requirement for all Eurozone government debt, but in a concession
to the German contingent — which strongly objected — the final
decision was restricted to Greek securities only.

MORE TOOLS IN THE ECB SHED

The sources made clear there were more tools in the ECB’s shed
should they be necessary, but they declined to be specific.

“We do have additional measures that can be taken,” said one
central banker who is an active participant in the discussions taking
place within Eurosystem monetary circles.

“But it doesn’t serve policymakers well to speculate on what steps
might or might not come next in the current environment,” he added. “We
need to be sure not to create expectations. In the current climate
that’s especially important, as false expectations can be highly
damaging.”

This official seemed to hint, though extremely obliquely, that in
order to avoid exacerbating market conditions the ECB may have declined
recently to make margin calls on Greek debt it is holding as collateral
— despite the recent sharp drop in Greek bond prices that would have
required the calls to be made in ordinary times.

Asked if the central bank had in fact made margin calls on Greek
debt, he coyly replied: “The current system is functioning with the
temporary suspension of some of the criteria.”

BUYING GOVERNMENT BONDS A HARD SELL

Of the many other potential tricks the ECB has up its sleeve, it is
clear that sovereign bond buying would still require a lot of convincing
before it ever got past the Governing Council.

One senior Eurosystem official suggested that buying the bonds of
any Eurozone government would be too strong a response since, in his
view, the Greece crisis was unlikely to spread in a serious way.

“There was no discussion about purchasing sovereign bonds and we
should not start talking about this possibility, because the Greek case
is special,” this official said. “It has particularities that have been
mounting over decades and cannot be compared with other countries such
as Portugal or Ireland or Spain.”

The first official expressed more flexibility on the subject. ECB
bond purchases are “difficult to envisage now,” he said. “I can’t see
the national central banks going out and buying up Greek bonds wholesale
— although these are exceptional times and things move fast.”

He acknowledged that banks in most Eurozone countries have exposure
to Greek debt, “so there could hypothetically be an argument at some
point that there are financial market and contagion issues related to
Greek assets.”

But “concerted bond buying” by the ECB would require “an extension
of powers,” the official argued. “You would never say never, but the
role of the ECB is to ensure stability in the financial sector…it was
not envisaged as a monetary bailout tool for governments.”

The officials seemed to believe that for now Greece has bought some
time, both with the E110 billion EMU-IMF aid package and the ECB’s
decision to drop minimum rating standards for Greek debt – which should
ensure greater liquidity for Greek banks and for other Eurozone banks
holding Greek securities.

GREECE COLLATERAL DECISION IN LINE WITH STABILITY MANDATE

“We have viewed the Greek situation as a whole and decided that in
order to recover and regain the markets’ trust, Greece should first be
protected from market behavior,” the senior Eurosystem official said.
“What I mean is that rating agencies have contributed significantly to
the development of the current crisis, especially concerning Greece, and
their attitude was not in line with the outlook and forecasts.”

He denied that the ECB’s most recent collateral decision, and the
one in March when it extended looser rules into 2011, contradicted the
ECB’s core stance. “We have said it many times that we take no ex-ante
decisions and that at times of crisis we will do whatever necessary to
protect the euro and price stability,” he said. “Our decisions on Greece
fall in this category.”

A second senior Eurosystem source concurred with this analysis. “It
was a message to the markets that the euro is and will remain strong and
that the ECB is not inflexible, but safeguards the Eurosystem,” he said.

He added: “If you ask me, it was also a clear message to the IMF of
who is in charge.”

That comment underscored the resentment and wariness with which
many senior ECB officials regard the IMF’s involvement in the Greek
plan. Top members of the ECB’s Executive Board, including Lorenzo Bini
Smaghi, Jose Manuel Gonzalez Paramo and Trichet himself, strongly
opposed IMF participation but were then forced to accept it publicly —
and backpedal furiously — once the politicians decided.

However, their view is not unanimous. “It’s been a very good thing
having the IMF,” the first source said. “The conditionality is very
strong and the [aid] package has been assembled in a very smart way. It
lends a lot of credibility.”

DENYING DEBT RESTRUCTURING, DOWNPLAYING CONTAGION FEARS

The sources took pains to deny that a restructuring of Greek debt
is in the works, despite a strong conviction in financial markets that
it is.

“There has been no discussion on restructuring Greek debt and I
don’t see there is a reason to keep putting it on the table since it
creates a constant rumor mill,” said the first senior Eurosystem
official.

A fourth central banking official said he doubted a restructuring
“would be necessary when you have [EMU-IMF aid] that will cover
borrowing through 2010, and by then the deficit should be falling.”

“The only fear is that the Greek government relaxes its efforts,
but with the IMF the ECB and the Commission monitoring, hopefully that
won’t happen,” he said.

But in perhaps his most revealing remark, this official conceded
that with Greece in a deep recession, “you won’t get” the first-year
deficit cut — 5.5 percentage points of GDP — that’s envisaged in the
budget plan.

The sources also vigorously sought to dispel the notion of a
contagion to other deficit-ridden peripheral countries.

“There’s no fundamental reason to compare Greece with Spain and the
other countries that are cited,” said one of the central bankers.

“I don’t see a domino effect here,” said the first senior
Eurosystem official. “But the council will continue to monitor very
carefully the market behavior now that the Greek situation is being
dealt with.”

–Paris newsroom, _331-42-71-55-40; paris@marketnews.com

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