BRUSSELS (MNI) – Policies that could undermine trust in the
European Central Bank, such as quantitative easing, will fail to restore
the confidence of financial markets or citizens, European Central Bank
President Mario Draghi said in an interview with the Financial Times,
published on the paper’s website Sunday night.

“The important thing is to restore the trust of the people —
citizens as well as investors — in our continent,” Draghi said. “We
won’t achieve that by destroying the credibility of the ECB. This is
really, in a sense, the undertone of all of our conversation today.”

Draghi’s comment was in response to a question about whether a
recession in the Eurozone might force the ECB to consider large-scale
government bond purchases in order to boost growth.

Draghi also warned of the limits of monetary policy, saying it
“cannot do everything.” Countries’ borrowing costs are typically the
result of their own fiscal policies and health, he told the FT.

Draghi dismissed the notion that the ECB’s recent move to extend
“unlimited liquidity” to banks for up to three years was a device to
encourage them to lend to Eurozone governments at cheap rates. The aim,
he said, was to ease banks’ funding difficulties, thus helping keep
credit lines open to small and medium-sized companies.

“What we are observing is that small and medium-sized banks are the
ones having the biggest funding difficulties, and [banks] are generally
the ones who provide most of the financing for the SMEs,” Draghi said.

Draghi criticized EU leaders for “sequencing” errors in their
response to the crisis, arguing in particular that this month’s stress
test by the European Banking Authority to identify how much extra
capital EU banks should raise to protect themselves from the crisis was
a mistake.

“Ideally, the sequence ought to have been different,” Draghi said,
arguing that the EU should have waited for the European Financial
Stability Facility to be fully operational first. “This certainly would
have had a positive impact on sovereign bonds, and therefore a positive
impact on the capital positions of the banks with sovereign bonds in
their balance sheet.”

Forcing private investors to take losses on their holding of Greek
bonds in the restructuring of that country’s debts was also a
“sequencing” slip, he said.

“The EFSF was not in place, nor were banks recapitalised before
people started suggesting PSI?,” he noted. “It was like letting a bank
fail without having a proper mechanism for managing this failure, as had
happened with Lehman.”

The Eurozone’s failure to get the EFSF up and running quickly has
also raised the cost of stabilizing markets, Draghi argued.

“The delay in making the EFSF operational has increased the
resources necessary to stabilise markets,” he said. “Why? Because
anything that affects credibility has an immediate effect on the
markets. A process that is fast, credible and robust needs fewer
resources.”

Nevertheless “it is premature and probably wrong to proclaim the
EFSF dead,” Draghi said, adding that the ECB, which is to act as an
agent for the fund, was aiming to have it up and running in January. “I
think that if one can show its usefulness at its present size, the
argument for its enlargement would be much stronger.”

EU leaders will be re-examining the adequacy of their “firewalls”
in just three months’ time, a point that many have overlooked, Draghi
said.

Despite his evident frustration with the slow pace of EU policies
to address the crisis, Draghi defended the EU’s general approach of
emphasizing fiscal austerity and structural reforms. “There is no
trade-off between fiscal austerity and growth and competitiveness,” he
said.

Even if a country could abandon the euro, it wouldn’t help much,
the ECB president argued. “Leaving the euro area, devaluing your
currency, you create a big inflation, and at the end of that road, the
country would have to undertake the same reforms that were due to begin
with, but in a much weaker position.”

Speaking about Italy’s experience with exchange rate devaluation,
Draghi noted: “It brought a temporary respite to the economy, so that
exports could grow, but it also widened sovereign bond spreads because
the exchange rate risk came on top of sovereign risk.”

–Brussels bureau: Peter Koh, +324-9522-8374; pkoh@marketnews.com

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