October 31, 2011 / 11:41 AM / 8 years ago

Draghi takes ECB command facing trouble on all fronts

FRANKFURT (Reuters) - A raft of policy and personnel conundrums await Mario Draghi when he takes over the helm of the European Central Bank on Tuesday, with pressure from Germany and the euro zone’s debt weaklings pulling him in different directions.

Incoming European Central Bank (ECB) President Mario Draghi speaks at the "World Savings Day" meeting in Rome October 26, 2011. REUTERS/Stringer

The success of Draghi’s presidency is inextricably linked to developments in his native Italy, where a failure by the government to deliver on economic reforms to boost growth and cut a huge public debt would raise pressure on the ECB to act as a backstop.

The euro zone has bailed out Ireland and Portugal, and come to Greece’s aid twice, but the Italian economy, the bloc’s third largest, would stretch governmental resources to breaking point if it succumbed. The ECB, on the other hand, could bring virtually limitless ammunition to bear.

Draghi appeared to indicate last week he stood ready to help tackle the euro zone debt crisis by going on buying the bonds of troubled states, though outgoing ECB chief Jean-Claude Trichet told Reuters the Italian’s remarks had been over-interpreted.

Controversy over the ECB’s bond-buy programme — begun in May 2010 — has led to the resignation of two ECB policymakers from Germany, where many people feel the plan took the bank beyond its monetary policy remit and into the fiscal arena.

Draghi would meet fresh German resistance to any push to buy more bonds, a tool which helps ease government borrowing costs, especially after last week’s EU summit deal to boost the firepower of the bloc’s EFSF rescue fund to 1.0 trillion euros, which could allow it to do the same job.

Bundesbank chief Jens Weidmann has said the crisis deal will redraw the boundary between monetary and fiscal policy — a line many in Germany felt was blurred by the bond-buying programme.

An Italian crisis would escalate matters to a whole different level.

“Should Italy wobble, then even the billions that are now going to be pumped into the rescue fund will no longer suffice,” said one person close to Weidmann, speaking on condition of anonymity.

“It depends on the politicians in Rome whether the summit is a success and the ECB can stop buying government bonds.”

Italy’s borrowing costs jumped to record levels at an auction on Friday, underlining its vulnerability and scepticism about whether the struggling government of Prime Minister Silvio Berlusconi can deliver promised economic reforms.


Draghi’s comments on bond-buying have sowed confusion over his stance on the ECB’s crisis response policy before he has even taken up the presidency. The episode highlights the importance of communication his new role.

His skills will be tested almost immediately when he faces the media on Thursday to present the ECB Governing Council’s latest monetary policy decision.

Financial markets, which have grown accustomed to Trichet’s coded language over the last eight years, will be listening closely for any changes in nuance or approach.

The inflation-fighting focus of the German contingent on the Governing Council means Draghi will have a hard time cutting interest rates to help support economic growth in the euro area, which he said last week faces significant risks of slowing.

Euro zone inflation held at 3.0 percent last month, data showed on Monday, way above the ECB’s target of close to but below two percent.

Draghi has gone to some lengths to establish his hawkish credentials. To cut rates at his first meeting in charge — or even in December when the ECB will have fresh economic forecasts of its own — would stoke German fears that an Italian dove has taken the helm of the central bank.

But to keep rates at 1.5 percent while other central banks are much lower and even deploying fresh stimulus would risk worsening a euro zone economic slowdown.

The OECD forecast on Monday that the currency bloc would grow just 0.3 percent next year.

Belgian ECB policymaker Luc Coene has even flagged the risk of a recession. But German Juergen Stark — who is quitting the ECB this year in what sources say is a protest at the bond-buying plan — said last week rates were “adequate.”

The memory in Germany of hyper-inflation in the 1920s, when a wheelbarrow full of cash was needed to buy a loaf of bread, has left Germans with a strong aversion to price rises.

Draghi was only able to secure himself the ECB presidency after German Axel Weber, who had been in pole position for the post, quit as Bundesbank chief earlier this year.

The Italian succeeds Trichet, who prides himself on having delivered price stability.


Many in Germany, where the people reluctantly surrendered their beloved Deutschmark for the euro, are concerned the ECB will now be headed by two policymakers from southern Europe — Draghi and Portugal’s Vitor Constancio.

These personnel issues are compounded by another pressing problem for Draghi: his compatriot Lorenzo Bini Smaghi, who also sits in the ECB’s six-member Executive Board, is at the centre of a diplomatic row between Italy and France.

Under a deal in April, French President Nicolas Sarkozy gave his support for Draghi to take over the ECB presidency provided that Bini Smaghi would make way to ensure a Frenchman remained on the board.

Bini Smaghi, whose term at the ECB expires in 2013, has insisted that any attempt to force him to leave would be an attack on the central bank’s independence, and he has received the backing of the institution.

Italian Prime Minister Silvio Berlusconi has urged Bini Smaghi to resign soon to stop relations between France and Italy souring further.

“I’m sure that Bini Smaghi will realise that he cannot be the causus belli of a relationship that is worsening between us and France and that he will quit by the end of the year, as it was agreed,” Berlusconi said after meeting EU leaders last week.

“Sarkozy has started to get annoyed ... At a certain point I said to Sarkozy, ‘But what am I supposed to do? Kill him?’”

Editing by Mike Peacock

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