Stark’s shock exit from ECB yet another blow in a deepening crisis

THE resignation of the top German official at the European Central Bank couldn’t have come at a worse time for eurozone policymakers as they search for a way out of the deepest crisis in the currency’s 12-year history.

The ECB is the institution that has kept the eurozone afloat in the sovereign debt crisis and prevented a bond market meltdown.

Juergen Stark’s departure from the ECB’s executive board in despair at the policy of buying government bonds to prevent the crisis spreading comes as policymakers in Berlin and beyond prepare for the growing possibility of a Greek default.

“It’s the ECB that is holding the show together, so anything that weakens the ECB is bad news,” said an EU official involved in financial crisis management.

Stark’s departure will sap the ECB’s credibility with Germany’s conservative financial establishment, which saw the bond-buying as an improper means of financing government debt.

That could make greater fiscal integration in the eurozone politically harder to achieve at a time when chancellor Angela Merkel is coming to realise that a big leap forward in economic governance is needed

At worst, Stark’s departure may constrain the ECB’s ability to act decisively in the coming months when the debt crisis enters an even more dangerous phase.

Jean Pisani-Ferry, director of the Bruegel economic think tank in Brussels, said: “If the ECB is shackled in its ability to buy Italian and Spanish bonds and at the same time we have to do a real restructuring of Greece’s debts, with a proper haircut, we risk a contagion shock spreading to other countries. If the ECB is hamstrung by a lack of consensus, that is the risk.”

A growing number of policymakers, as well as market economists, are convinced it is only a matter of time before Greece, which keeps falling behind on its fiscal targets, defaults.

A source at the weekend’s G7 finance chiefs’ meeting in Marseilles said the troika of EU, ECB and IMF inspectors, who suspended talks with Athens last week, would probably find a formula in its progress report to allow the next €8 billion tranche of bailout funds to be paid in October.

That would keep Greece going for a couple more months until European parliaments approve new powers for the EFSF rescue fund to give preventive credit lines to eurozone member states, buy bonds in the secondary market and lend money to recapitalise banks.

Markets may bid up eurozone bond yields again in anticipation of the ECB pulling out of bond-buying and handing over to the inexperienced EFSF.

The ECB has bought a total of €135bn worth of Italian, Spanish, Greece, Irish and Portuguese bonds.

The rescue fund may find itself short of firepower in a crisis. It will have about €380bn in uncommitted funds. Italy alone has €1.9 trillion of outstanding government bonds, of which 45% are held by foreigners.

The replacement of Stark on the ECB board by the more pragmatic German junior finance minister Joerg Asmussen, the seasoned crisis manager proposed by Berlin on Saturday, may reduce ideological tensions at the central bank.

But it could also force incoming ECB president Mario Draghi, who succeeds Jean-Claude Trichet on November 1, to take a harder line on ending bond purchases and sticking to the bank’s core mandate of fighting inflation.

Draghi has already warned governments that continued bond-buying cannot be taken for granted.

“Politics has never been completely absent from the ECB but this has now been reinforced. This awakens the idea that the ECB is still a structure that amalgamates national institutions and views, not primarily individuals belonging to its board,” Pisani-Ferry said.

“You have to think about how this looks from New York. It looks as if these people can’t even sit around the same table and work things out.”