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European Central Bank (ECB) president Mario Draghi.

ALEX DOMANSKI/REUTERS

The European Central Bank's warning that Europe's economy is nowhere near recovery increases the odds that Spain will tap into the ECB's new bond-purchase program before the country finds itself trapped in a funding crisis.

At the ECB's monthly meeting Thursday, held in Slovenia, ECB president Mario Draghi had no reassuring words about the state of the economy in the 17-country euro zone, whose gross domestic product fell 0.2 per cent in the second quarter.

"Economic growth in the euro area is expected to remain weak, with ongoing tensions in some euro area financial markets and high uncertainty weighing on confidence and sentiment," Mr. Draghi said.

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A credit squeeze on businesses is putting pressure on the economy. The ECB noted that wildly divergent interest charges on business loans had caused "fragmentation" in the euro zone, with rates in Spain for a €1-million loan reaching 6.6 per cent. The same loan would cost a German company only 3.8 per cent.

Apparently aware that Spain cannot count on an economic reversal to repair its economy, Mr. Draghi reiterated several times at the ECB's news conference that the bank's new sovereign bond purchase program – known as Outright Monetary Transactions (OMTs) – could swing into action quickly if a financially distressed country were to ask for help.

"We are ready and have a fully effective backstop in place," he said, adding that the euro is "irreversible."

At the press conference, Mr. Draghi was asked repeatedly if Spain is on the verge of a bailout or could avoid one. He would not comment directly, reiterating the ECB's stance that it is up to governments to request assistance, not for the ECB to offer it in the absence of a request. "That's up to Spain to decide, and the other Euro area governments to decide," he said.

Despite the stalled euro zone economy, the ECB left interest rates unchanged, as did the Bank of England, because the economy has not fundamentally changed since the last ECB meeting in September and inflation remains stubbornly high. It was running at 2.7 per cent in September, up from 2.6 per cent in August, in good part because of high energy prices.

The target rate is 2 per cent or less. Mr. Draghi said he expects inflation to drop next year.

He appeared to be encouraging Spain to take advantage of the OMT program, which was unveiled a month ago, after Spain's sovereign funding costs reached unsustainable levels. He implied that the launch of the OMT , which would have to come at Spain's request, would not automatically come with tougher demands for austerity. "Conditions don't necessarily have to be punitive," he said. "Actually many of the conditions have to do with structural reforms, which have both a social cost but also great social benefits."

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Spanish president Mariano Rajoy this week denied that Spain was on the verge of asking for a bailout. , though a few weeks ago he said the government would go that route if its funding costs continued to rise .

Even though the OMTs have yet to start, and theoretically may never start, their mere presence appears have had a positive effect on the sovereign bond markets. On Thursday, shortly before the ECB meeting, Spain raised €4-billion of debt in a sale that met with strong investor demand. A three-year bond went out the door with a yield of 3.95 per cent, up slightly from the 3.84 per cent paid in the sale of a similar bond on Sept. 20 but well below the lofty yields demanded by investors in the summer.

But since the OMT's existence on paper has not delivered a sustained and deep reduction in bond yields in the weakest euro zone countries, investors assume Spain cannot avoid asking the ECB for help. The OMT program cannot be started in isolation. A country must first seek assistance from the new bailout fund, the €500-billion European Stability Mechanism, which would attach conditions to any assistance. Only then would the OMTs start.

Mr. Draghi unveiled few new details about the OMT. But he did say the program would be limited to countries that still had access to the debt markets, implying that Greece, which has been bailed out twice, need not apply.

Economists said Mr. Draghi's overall message on Thursday was that there was almost nothing more the ECB could do in the short term to fix the euro crisis and that governments would have to do the heavy lifting.

"With the OMT, the ECB has tackled and exorcised fears of an imminent euro zone breakup," said ING Financial Markets economist Carsten Brzeski. "For the time being, the ECB can lean back, watch and twiddle thumbs."

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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