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ECB could be ready to buy weak Italian, Spanish bonds

Recent statements by the European Central Bank suggest the body is committed to buying bonds from ailing eurozone members. France is behind the measure, but the German Central Bank still has reservations.

Mario Draghi, president of the European Central Bank (ECB), is a powerful man. With just a few words, he can influence global financial markets and impact whether interest rates will go up or down. He has earned the nickname Super Mario. Unlike many other figureheads within the European Union, Draghi has shown tremendous dedication to rescuing the euro.

He has announced he will save the euro with every means available to the ECB. Financial markets briefly rallied in response, with investors expecting the ECB to buy up troubled eurozone countries' government bonds. It might start doing so in the coming days.

Merkel and Hollande committed

ECB chief Mario Draghi

Draghi says he will use every available means to save the euro

On Friday, German Chancellor Angela Merkel and French President Francois Hollande jumped on the bandwagon. They said Germany and France would do everything they could to save the eurozone. The leaders also called for agreements from a June eurozone summit to be implemented.

Last month, eurozone members agreed that the rescue fund known as the European Financial Stability Facility (EFSF) will start buying government bonds. That fund is scheduled to be replaced by a bigger package called the European Stability Mechanism (ESM) later on.

However, the proposed purchase of government bonds will have to wait until September 12, when Germany's constitutional court is expected to rule on whether Germany can participate in the rescue fund.

German central bank demurs

Last year, the ECB bought government bonds on a grand scale to prop up Italy and Spain. However, Germany's central bank was highly critical of the move, since the ECB was not originally intended to take on governments' debts by buying bonds.

Unlike finance ministers within the eurozone, Draghi is able to act quickly and independently. It appears the crisis has reached such proportions in Italy and Spain that the ECB feels compelled to act.

French President Francois Hollande (R) welcomes German Chancellor Angela Merkel at the Elysee Palace in Paris, June 27, 2012

Merkel and Hollande have had their differences

"The large countries Italy and Spain are on the verge of loosing access to the markets," Jacques Cailloux, chief economist of Japan's Nomura bank, told the Handelsblatt paper.

Indeed, Spain and Italy are currently paying record interest rates they will be unable to afford in the long run.

Questions remain

With their common declaration, Merkel and Hollande signaled that despite past disagreements, they share the same goals.

Differences of opinion remain over the best way of reaching them. French Finance Minister Pierre Moscovici recently said the EFSF will buy ailing countries' bonds within a few weeks or months. The EFSF treaty permits the move, but it has not been done yet. That is because buying government bonds would bring the eurozone very close to pooling member countries' debt, which Berlin strongly opposes.

Hollande and Merkel's Friday statement does not clarify this contentious issue. Eurozone finance ministers are not scheduled to take on the proposed purchase of government bonds until their next meeting in mid-September.

Politicians sleepwalking?

Recent harsh criticism by 17 top European economists has not prompted the finance ministers to hold their meeting earlier. The economists accused politicians of sleepwalking into catastrophe. Calls to pool old debt into a single fund and set up eurobonds along with a banking union are not new.

However, Berlin has rejected the economists' suggestions for eurozone members to spread out debt liability, published in a study financed by a US think tank. Junior partners in Merkel's coalition have even called for Greece to stop using the euro.

The European Union flag flutters in the wind with the ancient Parthenon temple, right, and the Propylaea, left, at the Acropolis Hill, in Athens on Tuesday, Oct. 25, 2011

Greece's fate within the eurozone is on the line

In Greece itself, the "troika" of the European Commission (EC), the ECB and the International Monetary Fund are monitoring the progress of reform efforts. Early verdicts are not encouraging.

"Greece has strayed far off course," according to EU officials in Brussels.

All eyes on Greece

EC President Jose Manuel Barroso recently travelled to Greece for the express purpose of telling Greeks he wanted to keep them in the euro family. But he also wanted to see results from the reform efforts.

In light of the low confidence in Greece's ability to implement long-term reforms, new measures are being discussed. Some of Greece's creditors might have to agree to a new haircut on the interest rate for their Greek bond holdings. Yet that could in turn create significant losses for eurzone countries and doubts about the latest agreements on saving the euro.

Observers are eagerly awaiting details to emerge from the troika's Greek visit over the coming weeks.

Meanwhile, the ECB's council is scheduled to meet next Thursday. Draghi might announce the bank will move toward buying Italian and Spanish bonds. If the ECB does not act, southern European countries' downward spiral is likely to get even worse.

Author: Bernd Riegert /ai
Editor: Shant Shahrigian

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