HOW MUCH LONGER CAN ECB HOLD THE LINE / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

AGENDA

JANUARY 13, 2011.

How Much Longer Can ECB Hold the Line?

By TERENCE ROTH

The European Central Bank has staved off another euro debacle. How much longer can it hold out on its own? The question is answered by patchy pledges of more sovereign support from governments themselves.


Greek Finance Minister George Papanconstantinou has been able to reveal that the European Union within the next two months will take big decisions that will resolve the euro-zone debt crisis "once and for all."


He's seconded by European Commission President Jose Manuel Barroso, who wants more money in the EU's bailout fund and sees a pact next month, with broader scope for government support.


Germany, publicly at least, downplays the idea of stocking up the €440 billion ($574 billion) European Financial Stability Facility as "not pertinent." China and Japan have fewer qualms and helpfully have offered to pick up part of the tab, for undeclared reasons of their own.


That's pretty much in line with EU communication standards. But it's as good an indication as any that institutional Europe recognizes that investors need assurance of a thicker safety net or it will lose the struggle to save the common currency.


What is obvious is that the European Central Bank, the only EU institution standing between the euro and ruin, can't forever hold the creaking currency bloc together on its own.


The ECB's calculated purchasing of unwanted bonds from fiscally weak governments along the euro-zone periphery ensured a so-so result in a wobbly Portuguese bond auction. That feat prevented the next bailout of a euro-zone country as early as this weekend, with Belgium and Spain lining up as the next targets.


But few are fooled into believing that Portugal's trials are over. The ECB's saturation purchasing won't durably hold down high yields if investors worry about default. High debt-financing costs make a bailout inevitable, many economists still believe, leaving the currency bloc limping from test to test in the unblinking credit market.


The ECB is no longer containing its exasperation, recently berating "irresponsible" government treasuries and warning that its array of artificial monetary life-support systems aren't for ever, even if they have been extended already.

But now that euro-zone inflation has exceeded the ECB's inflation target for the first time since the beginning of the financial crisis, the central bank is beginning to worry more about its central mandate to keep inflation in line.


Special funding conditions for banks in poorer euro-zone countries and its bond-purchasing plans are frail defense against market fears of sovereign default. The ECB's support in open government bond markets helped knock down the interest rate Portugal had to pay, but the result at 6.7% is still deemed unsustainable.


So EU officials are girding for worse to come. A Portugal rescue plan might cost in the region of €60 billion, one euro-zone government official estimates. Earlier calculations of the price tag of a Spanish bailout tower over that and quickly exhaust available funding.


There is near consensus among EU governments that if other counties need to be bailed out the existing funds pledged won't be enough, suggesting a substantial increase in the EU's bailout fund.


Future meetings of European finance ministers, beginning early next week, also will study the proposal for a common debt-management office that collectively issues bonds for all euro-zone countries. Germany and other "core" countries hate the idea of subsidizing the debt-servicing costs of others at the expense of a rising cost of issuing its own debt.


Still, that could help take some of the air out of the risk premium demanded on bonds issued by high-debt euro-zone governments, up to a point. The nettlesome prospect of sovereign default and debt restructuring continues to weigh on the euro-zone government bond market. There also is the fear and loathing over the hits bond investors now will have to absorb on defaults after mid-2013.


ECB President Jean-Claude Trichet will take another rap at fiscal profligacy when he announces the results of the ECB's policy meeting Thursday. What markets will really want to hear is how much longer the central bank can hold the line without itself losing its way.


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