ECB Holds Rates Steady

The European Central Bank kept interest rates on hold today as President Mario Draghi waits for Spain to decide if it needs his help.

Policy makers meeting in Ljubljana, Slovenia, left the benchmark rate at a historic low of 0.75 percent, as predicted by 48 of 52 economists in a Bloomberg News survey. Four forecast a cut to 0.5 percent. Draghi will brief reporters on the decision, taken at one of the ECB's twice-yearly meetings outside Frankfurt, at 2:30 p.m.

A month after Draghi unveiled an unprecedented plan to buy the bonds of euro-area countries still mired in the sovereign debt crisis, Spain, the country most likely to take up the offer, is still mulling whether it wants to accept the conditions attached. At the same time, the euro-area economy probably entered a recession in the third quarter as the crisis damped spending and investment.

“From an economic perspective, we don't need another ECB rate cut,” said Christian Melzer, an economist at Dekabank in Frankfurt. “The focus isn't on rate changes but on Spain and a possible request for aid paving the way for the ECB bond program. It's up to Spain to make a move now.”

Spanish bonds extended losses today after an auction of two-, three- and five-year securities failed to exceed the maximum target of 4 billion euros ($5.2 billion) and the benchmark three-year yield rose.

Finance Minister Luis de Guindos has said officials are still considering whether they need European Union aid, which Draghi has made a condition for ECB intervention. Under his plan, a country must make a formal request to Europe's bailout fund to buy its debt on the primary market before the ECB considers buying bonds on the secondary market.

Italian Prime Minister Mario Monti cautioned last week that aid shouldn't hinge on more conditions than leaders already signed up to and the International Monetary Fund shouldn't need to police it.

“What people tend to forget is that the ECB's bond plan is only complementing the implementation of financing help agreed by the governments,” said Athanasios Orphanides, who was an ECB council member until May and now teaches at the MIT Sloan School of Management in Cambridge, Massachusetts. “So if prime ministers Rajoy and Monti are not happy about conditionality or IMF involvement, then they should take it up with their fellow leaders and not complain about the ECB.”

Bank of England

Spain's central bank governor, Luis Maria Linde, didn't attend the ECB council meeting today due to an appearance before a parliamentary budget committee. Separately, the Bank of England held its bond-purchase target at 375 billion pounds ($603 billion) and kept its key rate at 0.5 percent.

While the ECB waits on Spain, the euro-area economy is deteriorating. Manufacturing contracted for a 14th straight month in September and consumer confidence also declined.

The ECB last month forecast a deeper economic contraction for 2012 than it did three months earlier, saying gross domestic product will drop 0.4 percent instead of 0.1 percent. According to a separate Bloomberg survey, a majority of economists forecast a benchmark rate cut in December.

Draghi is also seeking to sell his bond-buying plan in Germany after Bundesbank President Jens Weidmann objected to it. In a bid to soothe concerns in Europe's largest economy, Draghi pledged to German lawmakers on Sept. 25 that any bond buying must be “accompanied by reforms from governments that address deep-rooted issues.”

De Guindos said Oct. 1 that officials are studying the ECB plan and will make the “best decision for the interests of the Spanish economy.” That followed the unveiling of a fifth austerity package in nine months. The government announced plans to borrow 207.2 billion euros next year, which would increase its debt load to 90.5 percent of gross domestic product.

“The fears of the Bundesbank now seem to be coming true, that the governments are finding it very difficult to fulfill the conditions so that the ECB can act,” said Christoph Kind, head of asset allocation at Frankfurt Trust, who helps manage about $20 billion. “I think the ECB had imagined things would run differently.”

No Conditions, No Deal

While Spain seeks the lightest possible terms from creditor governments and the ECB as a reward for austerity measures already implemented, it's unlikely that Draghi will agree to no-strings-attached bond purchases, said Laurent Fransolet, head of interest-rate strategy at Barclays Plc in London.

“If you don't have conditionality, you don't have a deal,” he said. “It's very unlikely that the ECB will back down on conditionality. The markets know that, they also know that this won't happen overnight, and that a lot of sequencing is involved.”

The Spanish 10-year yield reached a euro-era record 7.75 percent on July 25, before Draghi pledged the next day to do “whatever it takes” to safeguard the monetary union. It was at 5.88 percent today. Two-year notes were at 3.34 percent, up from as low as 2.71 percent on Sept. 7.

Bond yields are unlikely to surge because the ECB's plan has quelled investor concern for now, Fransolet said. “People are not going to short Spain if the ECB is only a phone call away.”

Bloomberg News

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