European Central Bank President Once Again Assuages Economic Worries and Aids Markets

By Paul Dykewicz

European Central Bank (ECB) President Mario Draghi gave further support to the markets Thursday when he said that he was prepared to move forward with his previously announced plan to buy the bonds of fiscally challenged euro-zone countries such as Spain that otherwise would need to pay increasingly high interest rates on the open market.

The implications are huge for investors, since the run up in equity markets in recent months has been spurred by central banks cutting interest rates and pursuing other monetary-policy easing measures. Without the intervention of central banks, the markets are vulnerable to a fall due to economic slowdowns in countries around the world.

The ECB’s Governing Council remains firmly committed to preserving the “singleness” of its monetary policy but Draghi acknowledged 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, he added.

However, Draghi stopped short of taking specific monetary action on Thursday.

“Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged, Draghi said at a press briefing Thursday.

But Draghi noted that the central bank’s previous announcement about its bond-buying program that would involve Outright Monetary Transactions (OMTs) helped to alleviate “tensions” and reduce concerns during the past few weeks. OMTs will enable the ECB to provide, under appropriate conditions, a backstop to avoid “destructive scenarios” with potentially severe challenges for price stability in the euro area, he explained.

“It is now essential that governments continue to implement the necessary steps to reduce both fiscal and structural imbalances and proceed with financial sector restructuring measures, Draghi said.

Right now, the euro zone is facing high energy prices and increases in indirect taxes in certain countries, with inflation rates expected to remain above 2% throughout 2012 before falling below that level again in the next year, Draghi said. Consistent with this picture, the underlying pace of monetary expansion remains subdued, he added.

“Inflation expectations for the euro area continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term, Draghi said.

Investors gained further support earlier this week when the Reserve Bank of Australia became the latest central bank to cut interest rates to combat economic sluggishness. Australia had been benefiting from a mining boom in the natural resource-rich nation but even that sector in recent weeks has proven vulnerable, as commodity prices have fallen and thousands of workers have lost their jobs.

Australia’s central bank cut its benchmark lending rate by 0.25 percentage points to 3.25%. A statement accompanying the decision explained that economic weakness in the country led to the move.

The central banks in China and Japan also have cut interest rates this year. The U.S. Federal Reserve Bank has been pursuing asset purchases and announced plans to continue to do so into at least 2015 to reduce borrowing costs, after adopting an historic zero interest-rate policy in December 2008.

Economic troubles around the world have forced the central banks to act, with a byproduct of assuaging the concerns of investors. Typically, rising corporate revenues and earnings drive equity markets higher but economic troubles have caused many companies to pre-announce that their results would not meet prior guidance.

Further signs of concern came from a World Bank report released this week that indicated the European debt crisis could linger for years. The annual development report released Monday found that an estimated 200 million people are unemployed worldwide and currently seeking work.

Risk is rising that the newest members of the workforce are suffering the most. Roughly 620 million youth, mostly consisting of females, are not working, according to the World Bank.