By Emma Charlton

BRUSSELS (MNI) – The European Central Bank is likely to tread more
carefully in phasing out its liquidity measures and could keep Eurozone
interest rates on hold for longer than previously thought, as the
sovereign debt crisis in the single currency area clouds the central
bank’s forward vision.

Out of its traditional comfort zone, and increasingly forced to
take a defensive and reactive stance, the ECB has failed to reassure
markets that actions taken to shore up heavily-indebted Greece will
contain the Eurozone’s sovereign debt crisis.

At a press conference Thursday, after the central bank announced it
would leave its main interest rate unchanged at 1%, ECB President,
Jean-Claude Trichet failed to address the market’s more pressing
concerns, as he faced a barrage of questions from reporters wanting to
know if the central bank was considering new emergency actions.

His answers were vague and evasive – avoiding the topic of
government bonds, failing to set out a clear road map on liquidity plans
and simply restating an earlier position on Greece and the huge debts
and deficits in other Eurozone countries.

Markets, looking to Trichet for reassurance, found none and the
Euro skidded to a fresh 14-month low of $1.2691 against the dollar.

Greek 10-year bond spreads widened 66 basis points over the German
Bund at +798 basis points and Portugal spreads widened 29 basis points
to +324, while Spain traded 15 basis points wider at +147 basis points
after the meeting.

Central to the disappointment was the idea that the ECB could
alleviate bond market pressures by buying government bonds, or at least
open the door to the possibility of doing so.

“We did not discuss this option,” Trichet said, repeatedly.

And he would not be drawn on whether one of his Council colleagues,
Bundesbank President Axel Weber, was opposed to buying government bonds.

“I won’t comment on what my Council colleagues might say,” Trichet
said. “We did not discuss the matter, and [I've got] nothing else to say
on that.”

Trichet was also maddeningly elusive when asked by Market News
International whether, in order to avoid exacerbating the situation in
financial markets, the ECB had declined to make margin calls on devalued
Greek debt the ECB was holding as collateral against loans to banks.

“We permanently review what we are doing, but at the present moment
we are applying what we have decided as regards our rules,” Trichet said
— failing to elaborate on what in fact they had decided.

An ECB spokesperson last week refused to speak on the record about
whether the ECB was obliged to make margin calls. But an MNI source
recently suggested — though nearly as obliquely as Trichet evaded the
question — that the bank had in fact not made them. Queried on the
subject, the source replied: “The current system is functioning with the
temporary suspension of some of the criteria.”

Debt and deficit levels in the 16-nation currency bloc are at their
highest since the euro was introduced in 1999, after tax revenues
plunged and government spending rose during the recession.

The worst offender, Greece, has been offered a E110 billion bail
out package by its fellow Eurozone countries and the International
Monetary Fund which will see it taken off the markets for 18-months.

But fears are growing that other high debt and deficit countries
like Portugal and Spain might need similar help.

“Greece and Portugal are not in the same boat,” Trichet said. “This
is obvious when you look at the facts and figures.” “I would say Spain
is not Greece,” he added, when challenged again on the subject later.

But a number of recent U-turns, announced at unpredictable times,
have made the ECB’s future moves increasingly difficult to predict and
the markets increasingly jumpy.

Earlier this year, the ECB reversed a decision on its minimum
credit threshold for collateral, saying it would keep it at BBB- beyond
the end of 2010 and then apply a range of graduated haircuts. It had
previously said it would revert the threshold to A- by the end of 2010.

On Monday, the central bank said it would suspend applying the
minimum credit rating threshold for marketable debt instruments issued
or guaranteed by the Greek government, after previously stressing that
it wouldn’t give special help to any one Eurozone member.

This unpredictability has eroded the ECB’s credibility in the
markets, with many participants holding the view that buying government
bonds is an option that will eventually have to be used.

The ECB’s caution on employing new extraordinary measures could
stem from concerns about inflation, which the ECB aims to anchor just
below 2% over the medium term. Buying government bonds or upping
liquidity provision could pose an upward threat to prices, and that is
likely to be on the mind of some of the ECB’s more hawkish members.

In its statement Thursday, the ECB changed its language on
inflation, making a distinction between global and domestic pressures.

“Monetary policy will do all that is necessary to maintain price
stability in the euro area over the medium term,” the ECB statement
said. It also introduced a new hawkish phrase that short-term inflation
risks are “tilted somewhat to the upside,” though over the medium term
they are “viewed as still remaining broadly balanced.”

Trichet stressed that the ECB still regarded price stability as its
primary focus and that the Greek crisis would not change that. “We are
inflexibly attached to price stability,” he said.

But with the Greek debt crisis and the threat of contagion
increasingly moving centre stage, the markets will be looking more and
more to the ECB to show it is in control, and they aren’t afraid to show
their disappointment when it doesn’t.

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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