ECB rates unchanged; markets await word on bonds

[August 02, 2012]  FRANKFURT, Germany (AP) -- The European Central Bank leaves its benchmark interest rate unchanged at a record-low 0.75 percent.

Markets are now waiting to hear bank President Mario Draghi speak at a news conference, hoping for more signals on whether the bank might buy government bonds in the open market. That could lower borrowing costs that are threatening to push Italy and Spain over the edge.

Draghi last week raised expectations the bank might take stronger action by saying the ECB would do "whatever it takes" to save the euro. But he didn't specify what measures he would take.

Markets are looking to the ECB Thursday, a day after the U.S. Federal Reserve held off taking further steps to support the shaky U.S. recovery. But the Fed strongly hinted it might take action soon.

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THIS IS A BREAKING NEWS UPDATE.
AP's earlier story is below.

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The head of the European Central Bank has vowed to "do whatever it takes" to save the euro. Markets want to hear more about what exactly Mario Draghi meant by that.

It's not clear how much Draghi will be able to add to his remarks last week during his news conference on Thursday, which is held after the bank's monthly meeting to set interest rates.

He will certainly get questions about what the ECB could do to intervene in bond markets and push down the high borrowing costs that are threatening heavily indebted governments such as Spain and Italy with financial collapse.

Draghi sent expectations soaring last week that the central bank of the 17 countries that use the euro might resume its purchases of government bonds after he said that high borrowing rates were "within our mandate" under certain circumstances.

High borrowing rates drove Greece, Ireland and Portugal to take bailout loans from the other eurozone countries so that they could keep paying their debts, and Greece had to ask creditors to forgo euro107 billion ($131.59 billion) in repayments. Italy and Spain, both of which have to constantly sell new bonds to pay off old ones that are coming due, are now under similar pressure. But if these countries -- the third- and fourth-largest governments in the eurozone respectively- find themselves locked out of bond markets by high borrowing costs, there are concerns that the eurozone's resources would be put under considerable strain if they asked for a bailout.

Analysts think the ECB will probably leave its key interest rate -- the rate it charges banks for loans, which influences other rates throughout the economy -- unchanged at 0.75 percent. Most of the focus is expected instead to be on the government bond market

"Amid the high expectations Draghi is hardly likely to want to appear empty-handed before the public," analyst Christoph Balz at Commerzbank wrote in a note to investors.

"Draghi is therefore more likely to stress the readiness of the ECB to take action rather than announce more concrete steps."

But he added: "Perhaps Draghi will pull a new rabbit out of the hat."

Draghi raised expectations when he said the bank could address high bond market rates if they were preventing the low interest rates set by the ECB from spreading through the economy. If the bank was to move to help reduce interest rates, the economic uncertainty surrounding a country would ease off, helping it to get its finances under control.

However, Draghi has not said what the bank might do.

There are several possibilities but each has problems. One of the obstacles is that legally the bank cannot intervene in bond markets simply to make it easier for governments to borrow. Its founding treaty forbids it from using its monetary powers to finance the 17 governments in the eurozone.

It has bought bonds before -- more than euro210 billion worth -- in a bond market intervention that started in May 2010 but that was stopped in March. The purchases were in an attempt to lower rates on the bonds of financially troubled countries, under the reasoning the ECB was seeking to spread its low interest rate policy throughout the eurozone, not simply to bail out governments.

Buying government bonds in the open market drives their prices up and interest yields down, since price and yield move in the opposite direction. But the ECB's bond purchase program didn't consistently drive down interest rates. That was because it was limited and because criticism from German officials led markets to believe the ECB might not be unanimously behind it.

Here's a look at some other possible plans:

• Have the ECB buy bonds along with the eurozone's bailout fund, which could set tough terms for governments to get support, such as progress on cutting their debt and deficits.

• Letting the eurozone bailout fund borrow from the ECB, giving it more financial heft.

• Buying bonds so that they reach a fixed yield in the market. This would draw a line in the sand that could deter market sell-offs of bonds.

• Giving up the ECB's status as a preferred creditor when it buys bonds. That status could be scaring off countries' other creditors, who might think there would not be any money left for them in case of a bond default.

There are downsides to all those ideas. For instance, the ECB has said it can't legally lend to the bailout fund.

Many analysts think the politics and legalities are so complicated that Draghi may not be ready to announce anything on Thursday.

[Associated Press; By DAVID McHUGH]

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