The European Central Bank is stepping in to prop up threatened euro zone bonds and the big banks that own them – a sobering acknowledgment that earlier efforts to contain the debt crisis aren't working.
Warning of "renewed tensions in some financial markets," ECB president Jean-Claude Trichet confirmed Thursday that the central bank is intervening in financial markets for the first time in four months.
And Mr. Trichet pointed the finger at the U.S. debt ceiling showdown for stoking market tensions in Europe.
"It's clear the world is intertwined," he told reporters after the bank opted to leave its key interest unchanged at 1.5 per cent. "What happens in the U.S. influences the rest of the world."
The two-pronged ECB intervention highlights a growing concern in Europe. Not only are the governments of Italy and Spain facing a punishing spike in interest rates on their debts, but the stress is spreading to the countries' biggest banks. Many of these banks have large holdings of sovereign bonds, and prices are tumbling, making those investments a lot less liquid.
European policy makers are now openly blaming each other for not doing more to ease the crisis and prevent contagion from spreading to Italy and Spain.
In a letter to European heads of government, European Commission President Jose Manuel Barroso acknowledged that "bold decisions" taken at a July 21 summit "are not having their intended effect on the markets." And he complained that the main reason behind Spain's and Italy's market woes was "the undisciplined communication and the complexity and incompleteness of the 21st July package."
That has led to "a growing skepticism among investors about the systemic capacity of the euro area to respond to the evolving crisis," he said.
The surprise intervention suggests European policy makers are now playing a high-stakes game of catch-up after failing to defuse the crisis by twice bailing out Greece, as well as rescuing Ireland and Portugal.
The ECB immediately started scooping up Irish and Portuguese government bonds in what analysts said was a symbolic show of force in financial markets.
The ECB also said it would lend as much cash as commercial banks need for up to six months at the ECB benchmark rate.
Investors appeared unmoved. European stocks tumbled to a level not seen since after the financial crisis in mid-2009, the euro tumbled against the U.S. dollar and the cost of insuring banks against default neared a record.
The ECB moves are a tacit acknowledgment that policy makers are still struggling to get out in front of the crisis. At an emergency meeting July 21, European leaders agreed to give a euro zone bailout fund vast new powers to buy sovereign bonds. But they didn't give the so-called European Financial Stability Facility any more money, and the changes aren't due to be voted on by euro member countries until late September at the earliest.
So the ECB is now left to fill the vacuum, and to ease fears that the €440-billion ($607-billion) fund is far too small to cope with a bailout of either Italy or Spain, the euro zone's third- and fourth-largest economies.
The EC's Mr. Barroso said as much Thursday, calling for a "rapid reassessment" of the rescue fund. He reportedly wants an increase in the size of the fund that would be large enough to convince financial markets that it was capable of mounting bailouts for Italy and Spain.
But that doesn't sit well with the Germans, who have repeatedly blocked attempts to enlarge the bailout fund.
The crisis that began in Greece has now spread to Italy and Spain, significantly inflating the scale of the crisis – and the cost of resolution.
Helping to fuel investor angst is the perception that European leaders are unsure what to do about the crisis, and sometimes working at cross purposes.
Mr. Trichet, for example, acknowledged that Thursday's decision to resume emergency bond buying was not unanimous at the ECB governing council.