The European Central Bank acted to increase its financial firepower in the eurozone debt crisis on Thursday by deciding to almost double its capital to cope with increased credit risk and market volatility. The ECB, in charge of monetary policy in the 16-nation euro area, announced the move as European Union leaders gathered in Brussels for a summit dominated by the search for ways to stop market contagion engulfing more high-deficit member states.
-- Merkel and Juncker patch up differences
-- Spain and Portugal told to improve budget outlook
European Commission President Jose Manuel Barroso was set to tell EU leaders that the rolling debt crisis posed a systemic threat to the single currency zone requiring a comprehensive response, according to draft key messages seen by Reuters. The Frankfurt-based ECB said it would raise its subscribed capital to 10.76 billion euros from 5.76 billion euros by the end of 2012 in the first such increase in is 12-year lifetime.
"We infer from this that the ECB ... is seeking a greater cushion in order to offset potential losses, given that its portfolio of securities holdings has risen substantially, as well as to protect itself from potential collateral losses," Barclays Capital economists said in a research note.
The central bank has bought some 72 billion euros in eurozone government bonds since May but has resisted political pressure to substantially step up these asset purchases to help indebted governments avoid having to seek a bailout. Barroso was set to tell the 27 leaders that the crisis required broader measures by the whole single currency area as well as specific measures by individual states such as Spain and Portugal to put their finances in order.
"The current sovereign crisis has now become systemic in nature, and is driven not only by budgetary fundamentals but also by the mispricing of credit risk by investors and short-term herding behaviour in the markets," the draft talking points said. A Commission spokeswoman said his speech text had not been finalised. The two-day EU summit comes as Portugal and Spain face growing bond market pressure after heavily indebted Greece and Ireland received EU/IMF bailouts in return for implementing harsh austerity measures.
Echoing IMF chief Dominique Strauss-Kahn, who has criticised Europe's country-by-country approach as inadequate, Barroso said a "comprehensive, swift and consistent" response was required. EU leaders are set to approve a change in their governing treaty to establish a permanent crisis resolution mechanism that would replace the temporary 440 billion euro ($580 billion) financial safety net created in May, which expires in 2013.
The planned European Stability Mechanism would make loans on strict conditions to member states shut out of credit markets, but also provide for private bondholders to share with taxpayers the cost of future debt writedowns on a case-by-case basis. German Chancellor Angela Merkel, the driving force behind the treaty change, designed to placate Germany's constitutional court, has sought to keep other ideas, such as increasing the size of the rescue fund or issuing eurozone bonds, off the summit agenda.
Merkel told reporters on arrival for a conservative leaders' pre-summit meeting in Brussels that setting up the stability mechanism was "a giant act of solidarity" and reaffirmed Germany's commitment to a stable, enduring euro. Merkel contends so-called E-bonds would remove the incentive for countries to balance their budgets, and would raise Berlin's borrowing costs. Juncker, who last week called Germany's instant rejection "un-European", confirmed he had made peace with Merkel but hinted he might raise the proposal at the summit anyway.
Ratings agency Moody's warned Spain on Wednesday that its debt could be downgraded, saying it was worried by big central government funding needs, indebted banks and regional finances. Spain's Treasury paid a high premium to sell long-term bonds on Thursday but found strong demand, in a test of investors' appetite for euro zone peripheral debt.
Portugal announced extra measures on Wednesday to cut red tape and bolster structurally slow growth, in a move to convince EU officials and financial markets it is doing enough to stave off the pressure to seek EU financial aid. EU leaders, whose end-of year summit started around 1500 GMT, were not expected to take new decisions on managing the immediate crisis, a lack of action financial markets could interpret as a sign of weakness when full-on trading resumes in the new year.
Throughout 2010, EU leaders have struggled to show unity and clear communication in handling the crisis, alternating between rushing out half-formed or contradictory proposals and dithering on the right course of action while markets burned. Apart from approving the treaty change, they are expected to discuss ways to improve the current temporary financial safety net, which with a smaller EU fund and International Monetary Fund contributions adds up to a potential 750 billion euros.