U.S. raises pressure for euro zone crisis action

FRANKFURT/BERLIN (Reuters) - The United States raised pressure on euro zone leaders to take decisive action to solve the region's debt crisis, notably by lowering troubled members' borrowing costs, on the eve of a crucial European Central Bank meeting.

U.S. Treasury Secretary Timothy Geithner said the euro zone must take steps including "bringing down interest rates in the countries that are reforming and making sure those banking systems can provide the credit those economies need".

He made the comments in an interview with Bloomberg Television recorded in Los Angeles on Tuesday, a day after he flew to Germany to meet Finance Minister Wolfgang Schaeuble and ECB President Mario Draghi. They were broadcast on Wednesday.

Italy and Spain, the euro zone's third and fourth largest economies, could lose access to credit markets as the risk premium that investors demand to hold their bonds rather than safe-haven German debt has spiraled to levels considered unsustainable in the long term.

Italian Prime Minister Mario Monti said Draghi's pledge last week to do whatever it takes to preserve the euro were "bold and appropriate", and said European leaders were weighing joint intervention by the ECB and the euro zone's rescue funds.

He predicted that the future permanent rescue fund, the European Stability Mechanism (ESM), would "in due course" be granted a banking license so it could tap ECB funds to buy almost unlimited amounts of bonds.

However, German Vice-Chancellor Philipp Roesler rejected pressure for the ECB to step in and cap the borrowing costs of troubled euro zone states, saying the central bank should stick to fighting inflation and not ease market incentives for reform.

"If you take away the interest rate pressure on individual states, you also take away the pressure on them to reform," Roesler, economy minister and leader of the Free Democrats, junior partners in Chancellor Angela Merkel's centre-right coalition, told reporters in Berlin.

He also reasserted Germany's firm opposition to letting the ESM borrow from the central bank, dubbing that "the road to an inflation union".

Draghi's comments last week stirred speculation that the ECB might take more radical steps when its policy-setting Governing Council holds its monthly meeting on Thursday.

Geithner said Schaeuble and Draghi had walked him through plans they were putting in place to try to solve the crisis, but he cautioned against expecting immediate action.

Past financial crisis showed that the longer it took to address the issues, the more they cost.

"I believe they understand that. That's why they've signaled they are prepared to move further. Now again, this is going to take time," he added.

Market expectations of a major ECB move this week have faded somewhat after a spike following Draghi's comments last week. Those traders and investors who expect action on Thursday would sell the euro and European shares and drive up Spanish and Italian bond yields if the ECB did nothing.

Nick Parsons, head of markets strategy at nabCapital in London, said the euro could fall a couple of U.S. cents from current levels, while bond market analysts expect Spanish yields to reach new euro-era highs if the ECB does not act.

MONTI ON TOUR

Monti, touring Europe to press for action to bring down Rome's borrowing costs, made his pitch to euro zone hardliner Finland on Wednesday, saying Italy did not need an assistance program but might in future need "a breathing break" from high interest rates.

"We have in mind a possible intervention through EFSF, ESM and the ECB," Monti was quoted as saying by Finnish daily Helsingin Sanomat before he met Prime Minister Jyrki Katainen.

Katainen told a joint news conference that interest rates were too high in some European countries such as Italy, and that sovereign bond markets were not properly assessing their economic situation.

Central bank sources have told Reuters that intervention could be at least five weeks away because Draghi's comments had not been agreed in advance with the Governing Council, and other elements must first fall into place.

The sources said the ECB could revive its mothballed sovereign bond-buying program in tandem with the euro zone's rescue funds, but Spain would first have to request assistance, which it has resisted so far.

Credit ratings agency Standard & Poor's affirmed Spain's sovereign BBB+/A-2 rating on Wednesday, citing its commitment to economic and fiscal adjustments, but warned it risks losing investment grade if euro zone support fails to boost confidence.

Euro zone leaders would have to agree to the rescue funds buying up government bonds, and the German Constitutional Court would have to uphold the legality of the bloc's permanent rescue fund in a ruling due on September 12.

The leaders have spent the past week issuing statements promising to take whatever steps are necessary to rescue the currency, but none has raised expectations as high as Draghi, who heads the only federal European institution able to act swiftly and decisively.

However, the ECB is divided, with Germany's Bundesbank opposed to reviving government bonds or giving the euro zone rescue fund a banking license.

Draghi met Bundesbank chief Jens Weidmann privately earlier on Monday to try to reconcile differences on what action the bank might take. Neither bank would comment on the meeting.

The Bundesbank released on Wednesday a June 29 interview for an in-house publication in which Weidmann said governments expected too much from the central bank, and what they wanted did not always make economic sense.

"Politicians overestimate the central bank's capacity and place too many demands of it," he said.

"Whether it's about interest rates or any sort of special measures, in the end it always comes down to the same thing: trying to rope the central bank into meeting fiscal policy objectives."

Weidmann said the Bundesbank would continue to defend its positions firmly "so that the (European) monetary union remains a stability union".

With the economy slowing and inflation under control, other options on the ECB's radar screen include a possible further cut in interest rates and a further loosening of rules on the collateral it will accept to lend funds to banks.

(Additional reporting by Terhi Kinnunen in Helsinki, Swaha Pattanaik and Richard Hubbard in London, Eva Kuehnen in Frankfurt; Writing by Paul Taylor; editing by Anna Willard and Will Waterman)

WhatsAppFacebookTwitterLinkedinBeloudBluesky