European Central Bank (ECB) President Mario Draghi quashed talk of an early exit from emergency stimulus measures as Spain struggled to borrow in financial markets, a reminder of the risk that the region’s debt crisis could flare again.
Speaking just hours after Spanish Prime Minister Mariano Rajoy warned his country faces “extreme difficulty,” Draghi said on Wednesday that talk of the ECB starting to withdraw its support for eurozone banks was “premature.” At the same time, in a nod to growing inflationary concerns in Germany, he said the ECB would not hesitate to counter price risks if needed.
Policymakers left their benchmark rate at a record low of 1 percent.
The ECB’s balance sheet has expanded by about 30 percent since Draghi took office in November last year, pumping more than 1 trillion euros (US$1.3 trillion) into the banking system in a bid to stem the debt crisis. Pressure to unwind the emergency measures is rising in Germany, where workers are winning some of the biggest pay increases in two decades, threatening to stoke inflation.
“Premature Bundesbank calls for an ECB exit strategy have now triggered a new round of market wobbles, with a focus on Spain,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The risk of a new irrational market panic remains serious.”
Spain, the eurozone’s fourth-largest economy, sold 2.59 billion euros of bonds on Wednesday, just covering the minimum amount targeted. After the auction, yields on the country’s 10-year bonds surged to more than 5.6 percent, the highest in three months.
“Spain is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty, and anyone who doesn’t understand that is fooling themselves,” Rajoy told a meeting of his People’s Party as he seeks to push through the deepest budget cuts in three decades.
Declining to comment directly on the Spanish auction, Draghi said governments must make use of the window of opportunity created by the ECB’s emergency measures to deliver on promised structural reforms and fiscal consolidation.
Draghi faces pressure from some ECB policymakers to start planning an exit as higher energy costs keep eurozone inflation above the central bank’s 2 percent limit and price pressures brew in Germany.
On Wednesday, the ECB hardened its tone on inflation in its policy statement, saying “all the necessary tools are available to address upside risks to price stability in a firm and timely manner” and that it would pay “particular attention to any signs of pass-through from energy prices to wages.”
Still, Draghi said the economic outlook is subject to downside risks and inflation would remain contained in the medium term.
The European Commission forecasts growth of 0.6 percent in Germany this year and contractions in Italy, Spain, Belgium, Greece, Cyprus, the Netherlands, Portugal and Slovenia. The eurozone economy is projected to shrink 0.3 percent.
“Single monetary policy naturally focuses on maintaining medium-term price stability for the eurozone as a whole,” Draghi said.
“It is up to national policymakers to foster domestic developments which support the competitiveness of their economies,” he said.
Spain is struggling with unemployment in excess of 23 percent and a budget deficit that has not been under the EU’s 3 percent limit since 2007. Investors began to doubt the country’s ability to carry a debt load of nearly 70 percent of GDP last year after the debt crisis spread beyond Greece. Spain’s debt-to-GDP-ratio may rise to almost 80 percent this year.