The new head of the European Central Bank signalled on Thursday it stood ready to act more aggressively to fight Europe's debt crisis if political leaders agree next week on much tighter budget controls in the 17-nation eurozone. Speaking a day after the world's major central banks took emergency joint action to provide cheaper dollar funding for starved European banks, Mario Draghi painted a dark picture of the state of the banking system.
"A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations," he told the European Parliament.
Draghi's signal lifted stock and bond markets hours before French President Nicolas Sarkozy was to outline his vision of closer euro zone integration in a televised speech (1730 GMT) ahead of a December 9 European Union summit seen as make-or-break for the eurozone.
German Finance Minister Wolfgang Schaeuble said he would propose at the summit that EU states set aside sovereign debt of over 60 percent of gross domestic product - the EU treaty limit - in special funds to be paid off over 20 years with national revenues. Draghi did not spell out what action the ECB might take, but it is under huge political and market pressure to massively step up purchases of eurozone government bonds or lend money to the IMF to support ailing Italy and Spain.
In the short-term, economists expect the central bank to relieve pressure on banks and an economy heading into recession cutting interest rates next week and announcing longer-term cheap liquidity tenders with easier collateral rules. Markets are pricing in a 25 basis point cut to 1.0 percent on December 8 and Draghi said nothing to dissuade them. In response to lawmakers' comments, he added that the ECB had scope to act within the European Union treaty and the most important thing was to make sure that frozen credit channels started to work again.
Draghi, who faces some of the toughest decisions in the currency's 12-year history after just one month in the job, said the ECB was aware many European banks were in difficulty because of stress on sovereign bonds, tight interbank funding markets and scarce collateral.
Markets were cheered by strong demand at Spanish and French bond auctions on Thursday. France's 10-year bond spread over safe haven German Bunds fell below 100 basis points for the first time since October 28 after peaking above 200 bps in mid-November. EU paymaster Germany is pressing for an agreement on treaty change to establish coercive powers to veto national budgets in the eurozone that breach agreed rules.
Berlin wants the European Commission to be empowered to reject national budgets before they go to parliament and to refer serial deficit offenders to the European Court of Justice. In Berlin, leaders of Merkel's centre-right coalition agreed that Germany's opposition to common eurozone debt issuance was non-negotiable, slamming one door which France and other southern euro zone states have tried to open. In a key policy shift, Schaeuble said on Wednesday Germany was now open to increasing the IMF's resources through bilateral loans or more special drawing rights, reversing the stance it took at last month's Cannes G20 summit.
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