Europe: Get IT Right

It's now up to the 17 eurozone leaders to come up with something dramatic to regain the confidence of markets after the European Central Bank refused to backstop the zone in bond markets.

But the pressure has returned to the zone's banks after news that regulators want them to raise 114 billion euros in new capital, a move that sent their shares slumping in late trading.

But don't expect anything too dramatic because German Chancellor Angela Merkel warned us not to from the meetings at the Brussels summit, which is the third or 4th of its kind this year.

She sees it as yet another step towards something concrete, but the way markets reacted, there may not be enough time for that to emerge.

As a result, markets sagged overnight Thursday after European Central Bank President Mario Draghi killed off any idea that the central bank would backstop Europe in its present woes through unlimited buying of bonds.

The news continued the losses seen in Asian trading in later dealings in Europe and the US where investors piled into bonds seeking a safe haven and driving the yield on 10 year securities under 2%.

Gold fell $US33 an ounce, silver and copper were weaker and oil dropped under $US100 a barrel in New York. The Aussie dollar lost a cent to trade around $US1.0170.

After the ECB leader's statement, Italian and Spanish 10-year bond yields rose more than 0.20%, climbing to 6.4% and 5.8%, which are worrying levels.

They could climb further if tonight's meetings are judged to be a damp squib.

Investors have concluded the ECB won't save Europe from itself and don't hold out much hope that anything convincing will come from tonight's meetings in Brussels of EU and eurozone leaders.

The ECB did however cut interest rates by a quarter of a percentage point to 1% and said it would supply banks with unlimited cash for three years.

But there will be no wholesale purchases of debts issued by under pressure countries such as Italy or Spain.

The current low scale purchases in secondary markets will continue, which is not enough to support the likes of Italy which has an estimated 300 billion euros of debt to issue in the first quarter of 2012.

The lending program will help support the region's banks and hopefully start thawing the credit freeze which has been gradually gripping the region.

The message to markets from the ECB is, don't expect it to save the eurozone (and the euro) with bigger purchases of government bonds or by lending to the International Monetary Fund.

It will be up to the politicians to devise a credible plan and judging on the performance of the last two years, that will be hard to achieve.

The ECB has been buying bonds in the secondary market now for well over a year and has around 200 billion worth of securities issued by Spain, Italy, Greece, Ireland and Portugal.

There has been speculation that the ECB would step up its bond-buying Securities Markets Program once European leaders put in place a new agreement enshrining limits on deficits and public debt.

The news has put a dampener on market confidence as EU and eurozone leaders met in Brussels.

Draghi told the post meeting news conference that he had not signaled the ECB would as a matter of course back additional purchases of the bonds of debt-strapped nations.

"The method by which money is being channeled to European countries should not obscure the fact that the treaty says no monetary financing to governments [...] The spirit of the treaty is always on our minds," he said.

Under the SMP, the ECB sterilises, or offsets, the impact of its bond purchases by draining a corresponding amount of liquidity from the financial system in a weekly operation.

If it was to step up its bond buying to act as a sort of lender of last resort, the ECB would have to undertake unsterilised bond buying, which is in effect printing money, just as the Bank of England, the Bank of Japan and the US Federal Reserve are currently doing.

Draghi also poured cold water on proposals that have circulated involving loans from euro-zone national central banks to the International Monetary Fund.

Those efforts were said to center on the idea that the IMF could then use the funds to make bond purchases.

"If the IMF were to use the money exclusively to buy bonds in the euro area, we think that is not compatible with the treaty," he told the conference, according to media reports.

The rate cut - the second in as many months - returned the ECB's key lending rate to the record low 1% that prevailed before the central bank's two ill-advised rate rises driven by Draghi's predecessor, Jean-Claude Trichet.

In his media conference, Mr Draghi said that policy makers currently see "substantial downside risks to the economic outlook for the euro area" in an "environment of high uncertainty."

And underlining the weakened economic outlook, the ECB slashed its forecast for growth next year to 0.3% from 1.3%, meaning many of the 17 member states will be in recession.

And while inflation will slow to 2% next year and 1.5% from the current 3%, the real problem for the zone is that the slump will build pressure for more spending cuts and tax rises to keep deficits and debt falling, an almost impossible task.

Meanwhile, the bank liquidity measures introduced which include the introduction of two three-year long-term refinancing operations, which will effectively meet all bank demand for collateralised loans at a fixed interest rate.

The ECB also lowered collateral standards while also halving reserve requirements, which in turn will increase the amount of capital available to banks.

The moves come after the ECB joined with the Federal Reserve and four other central banks last week to cut the cost of dollar-swap lines as European banks struggled to meet dollar-funding requirements.

The European Banking Authority said overnight that the aggregate capital shortfall for European banks amounted to 114.7 billion euros ($US152.7 billion), as it published results of bank-recapitalization plans that are part of measures agreed to by the European Council in October.

The EBA said that Greek banks had a capital shortfall of 30 billion euros, Italian banks - 15.37 billion euros, Spanish banks - 26.17 billion euros, German banks - 13.1 billion euros, Portuguese banks - 6.95 billion euros, and French banks - 7.3 billion euros.

The EBA said that national authorities will require banks to submit by January 20 their plans for reaching the targets, which means a working Christmas.'

News of the new capital needs have upset German bankers who feel the EBA has got it wrong.

Shares in the partly state-owned Commerzbank fell 10.7% in late trading, and investors concluded that the German government will have to stump up with the money, 5.3 billion euros, according to the Authority.

And that in turn raises another problem.

Standard & Poor's warned 15 of the 17 eurozone countries their credit ratings could be cut without a credible plan to support the finances of the zone.

And it warned on Wednesday night that should that happen, then ratings on banks across the zone would be cut, with those in France chopped two notches. Ouch!

They include French giants, Societe Generale, BNP Paribas, Credit Lyonnais, Germany's Deutsche Bank and Commerzbank. Their ratings and those in 13 other countries are on review for possible downgrades.

The ratings group said "We believe that the ratings on Austria, Belgium, Finland, Germany, the Netherlands, and Luxembourg could be lowered by up to one notch, if at all and those on Estonia, France, Ireland, Italy, Malta, Portugal, Slovak Republic, Slovenia, and Spain by up to two notches, if at all."

And S&P also warned that it could cut the AAA held by the European Union. S&P put the EU's rating on "creditwatch negative" after a similar action on 15 of the 17 Euro members. The EU's short-term A-1+ rating was affirmed.

So now we have the organisation at the heart of the eurozone on a warning, plus 15 of the 17 members and quite a few banks. Insurers and industrial companies will be next if the downgrades happen at national levels.

That's another incentive for the EU and eurozone leaders to do something decisive enough that it keeps S&P at bay. But will it?

We could go into 2012 with doubt hanging over the credit ratings of 15 of the 17 eurozone countries, the EU itself and dozens of banks, or all could have just seen their ratings chopped.

In other words, more turmoil and confusion on global markets. No wonder the Reserve Bank here cut rates this week, just to give our economy a bit more protection from Europe's woes crushing us, boom or no boom.