Eurozone Crisis: ECB Takes No Action As Markets Fear Greece Is Nearing The Edge

European Central Bank Takes No Action As Markets Fear Crisis Is Getting Worse

The European Central Bank (ECB) took no action after a meeting on Thursday, despite investor calls for intervention in a sovereign debt crisis that many believe to be worsening.

The bank held its benchmark interest rate at 1% in January. Markets did not react to the decision, and the euro remained largely unchanged against the dollar.

The eurozone is widely believed to be heading back into recession, and the ECB has been under considerable pressure to print money to buy sovereign debt.

The bank is expected, within the first quarter, to drop its rates even further in response to worsening economic conditions. However, the markets are still waiting for some meaningful action from the institution to backstop the eurozone's failing sovereigns.

Thursday's decision comes against a backdrop of increasing pressure on Greece, which appears to be slipping in its attempts to rein in its budget deficit, a condition of its bailout packages from the European Union and International Monetary Fund (IMF).

Analysts are increasingly raising the spectre of an unsuccessful meeting between Greece and the "troika" of the EU, IMF and ECB. The German-language paper Handelsblatt reported that the IMF has acknowledged that there is a hole of tens of billions of euros in the country's bailout package, which will need to be filled somehow.

The Greek government has also struggled to agree the size of a write-down on its debt with its private sector creditors. A "haircut" of 50% was a agreed back in October, but it since became clear that this was not deep enough to allow Greece to escape from its debt trap.

There is some speculation in the markets that the voluntary agreement might be replaced with a "hard restructuring" - a forced write-down that could constitute a default. That would have a wave of effects, triggering credit default swaps - financial products which are effectively a bet against the country's ability to pay back its loans - and causing shockwaves across the eurozone.

There are alternatives - the ECB could accept losses on its significant holdings of Greek bonds, for example - but politics stand in the way.

Germany has been insistent throughout the crisis that the private sector should shoulder much of the burden of losses from debt write-downs, and has consistently defended the ECB.

On the flip side, as Eurasia Group analyst Mujtaba Rahman said last night in a note to clients, the fact that the ECB is not involved in the write-downs "does throw up legal complications, as it gives the bank de-facto preferred creditor status for bonds that were purchased alongside other market participants in the secondary market. It also has potential implications for larger countries, where the ECB has been intervening in debt markets and which could be at risk in the future should reforms disappoint and sentiment deteriorate (for example, in Spain and Italy)."

A failure to agree on continued financial support, or debt write downs, for the stricken Greek economy might then push the country towards the euro exit door.

"We need to start preparing for the possibility that Athens might end up exiting the single currency," Simon Derrick, currency strategist at BNY Mellon, said in an email Thursday morning.

The other crisis response funds - the temporary European Financial Stability Facility (EFSF) and its permanent successor, the European Stability Mechanism (ESM) - are still the subject of heated debate amongst European governments.

The latter risks being held up by continued opposition from member states who fear that an agreement made in December to allow major reforms to the fund to be made on a qualified majority across the eurozone, rather than by an absolute majority. This means that smaller dissenting countries could be cut out of decision making, and could lose a major bargaining chip in their relationship with their larger neighbours.

Finland, which has a strong eurosceptic lobby, could be a the lead stumbling block in the process.

The euro is likely to suffer as continued uncertainty over not just Greece, but Spain and Italy, sees investors moving into safe havens.

"The risks that large Eurozone members like Italy struggle to fund their budgets deficits in 2012 and the high probability of a unilateral default by Greece in March will make long term investors including reserve managers and sovereign wealth funds reluctant to increase their exposure to the Eurozone," UBS economist Larry Hatheway wrote in a note to clients on Thursday morning.

The single currency hit fifteen-month lows against the dollar and the pound at the start of 2012, and Hatheway, like others, thinks it will continue to fall.

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