Draghi to urge European leaders to reform to back ECB stimulus

[December 12, 2014]  By John O'Donnell
 
 FRANKFURT (Reuters) - The head of the European Central Bank is set to tell European leaders in stark terms at a summit next week that they need to reform straggling economies or risk blunting an ambitious monetary offensive to help revive the stagnant euro zone.

As the central bank inches closer to printing money to buy government bonds, Mario Draghi has become increasingly worried about slack reform in countries such as France and Italy, which he fears will undermine the long-term boost from so-called quantitative easing (QE).

On Dec. 18, Draghi will urge leaders including French President Francois Hollande and Italian Prime Minister Matteo Renzi to step up reforms and hold down spending, people familiar with ECB thinking say.

He wants German Chancellor Angela Merkel, by contrast, to invest more in infrastructure and boost domestic demand.

Yet French caution, Italian fragility and electoral uncertainty in Greece mean Draghi is likely to come away without a political "game changer", forcing him to press ahead with QE regardless to avert a deflationary economic spiral.

ECB bond buying may give a temporary boost to confidence, but Draghi is convinced his efforts will be in vain in the longer run unless countries make a more binding commitment to shake up rules such as those for employees or taxation.

"The agendas of the French and Italian governments are the right ones but the implementation is not complete," one person familiar with ECB thinking told Reuters. "Europe can help through peer pressure."

COHESION AT RISK

In public, Draghi's appeals have become increasingly strident. He warned last month that failure to change could damage the "essential cohesion" of the euro zone, signaling that the euro's survival depended on it.

But European leaders, grappling with Eurosceptics who want to scrap the euro currency and with vested interests clinging to acquired rights, have little room to respond for now.

ECB officials have discussed with the European Commission, the EU's executive, the idea of "structural reform pact", a commitment signed by all 18 euro zone countries with benchmarks and peer pressure to encourage laggards.

"To the extent that this increase in governance can lead to more ownership at the national level and more commitment to the reforms, everybody will be better off," that person said.

An informal EU summit in February is due to discuss these ideas, but such a pact, if it ever comes, is a long way off.

Proposals by former European Council President Herman Van Rompuy for "reform contracts" offering financial incentives in return for binding reform commitments went nowhere. Northern states saw no need to pay partners to do what they should be doing anyway, and southern states refused to see reforms imposed from outside.

While unveiling timid steps to loosen a highly regulated economy, France has been defiant in overshooting EU budget deficit rules that limit the shortfall to 3 percent of output. It faces the threat of a possible fine in March unless it takes some corrective measures by then.

Parliament in Italy, which has a public debt that outstrips the size of its economy, has given Renzi a green light to reform labor market rules, but his much-trumpeted Jobs Act has yet to be implemented.

Renzi could face obstacles when he puts detail on his plans. Trade unions held a national strike against his plan on Friday.

Draghi also has Germany in his sights. The ECB would like the euro zone's largest economy to invest more to modernise its transport, energy and digital networks.

Privately, people familiar with ECB thinking deride the idea that the German economy is invincible as a misconception, noting that the last round of serious reforms was a decade ago.

Draghi, who will lend support on Thursday to the European Commission's plan to bolster investment, cannot wait for Europe's leaders before launching QE because the economic slowdown is so acute.

But he will tread carefully in giving advice and avoid any appearance of a trade-off for bond-buying.
 

"There cannot be an offer of QE in return for reforms," said Clemens Fuest, head of the influential Centre for European Economic Research (ZEW).

"This would mean that Europe would be governed by Mario Draghi and that cannot be allowed to happen."

(Editing by Jeremy Gaunt and Paul Taylor)

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