–First Ran At 1300 GMT/0900 EDT Thursday

ROME (MNI) – The Eurozone has no choice but for its governments to
cut budgets and for the European Central Bank to withdraw its “strongly
expansive” monetary policy, ECB Governing Council member Mario Draghi
said Thursday.

“The economic policy path today is narrow and arduous,” Draghi, who
heads the Bank of Italy, said in the text of a speech to a conference of
the Italian Bankers’ Association. “There are no alternatives to
restoring the health of public budgets, to the withdrawal of monetary
expansion, to the recapitalization of the banking system, and to the
return to a culture of stability, which was the founding characteristic
of the euro area.”

Once the recovery is confirmed, “it will be necessary to resume the
gradual exit from non-conventional monetary measures,” Draghi said.
“Even with the pause of the past week, following the renewed strong
tensions that originated in the market for Greek public securities, this
process has been underway since the end of 2009.”

And, “an acceleration of the end to public budgetary imbalances is
indispensable,” he said. “The effect on the recovery will be positive if
the return to [fiscal] health contributes to a reduction of spreads on
sovereign securities.”

Despite loose monetary policy and burgeoning public debt and
deficits, “inflation expectations [in the Eurozone], unlike in other
countries, remain solidly anchored,” Draghi said.

Draghi urged “maximum transparency in the communication” of
European bank stress test results. The tests will apply to 91 European
banks accounting for 65% of system assets, and the results are scheduled
to be published July 23.

“On that date, European governments must be prepared to intervene
with the appropriate measures, wherever the results show capital
weakness and market solutions are not available.”

With regard to Italian banks, Draghi said that while results will
differ from institution to institution, “I am confident that they will
show that the capital resources of individual businesses are adequate.”

Draghi said that the “selectivity” of Italian banks in calculating
risk capital “is reflected in a quality of capital at Italian banks that
is comparatively high and will help facilitate the move to new, more
stringent Basel [bank capital] standards.”

Moreover, he said, the Italian banking system has remained largely
in the core business of traditional loan granting, and therefore the
stiffening of capital requirements in the face of trading activity
should have a “smaller impact” compared with other countries.

On the economic front, Draghi said the global recovery is “uneven
and uncertain, but it is continuing.” The recovery in Europe, which is
“driven by international trade, remains exposed to risks. Among them, he
noted, are the “lingering weakness of domestic demand in our countries;
turbulence on financial markets which, still fragile, overreact to the
heightened perception of sovereign risks; [and] possible inflationary
tensions from emerging countries, which could induce a more restrictive
policy.”

In Italy, renewed vigor in foreign trade is helping drive the
recovery, Draghi said. He noted that the Bank of Italy’s Economic
Bulletin, to be published today, will project an increase of 9 percent
in export volume this year and 5% in 2011. Still, he said, “consumption
and investment remain weak, because real incomes are stagnating [and]
the employment outlook is uncertain.”

Draghi said that the ECB’s government bond purchases “prevented a
collapse of the European financial system, preserving the monetary
policy transmission mechanism.” The bank’s commitment to sterilize the
bond buys “remains firm,” he said.

He noted that after the E442 billion LTRO expired July 1, the large
volume of cash leaving the system has not been fully replaced by
subsequent refinancing operations.

“Since some counterparties still have difficult access to market
funding, that translated to a moderate rise in money market rates, on
the order of 10 basis points,” Draghi noted. “The direction of monetary
policy should not be altered because of the conditions of these marginal
counterparties,” he said. “Their problems must be confronted by the
[corresponding] national authorities.”

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