Trichet Plays for Time as Greek Debt Crisis Spreads

May 7 (Bloomberg) -- European Central Bank President Jean- Claude Trichet played for time as Greece’s fiscal crisis spread across the Atlantic to drive stocks down from the U.S. to Asia.

The euro slid to a 14-month low yesterday and the Dow Jones Industrial Average dropped the most in a year after Trichet resisted taking any new steps to stem contagion. The ECB hasn’t discussed the option of buying government bonds and the onus is on European politicians to cut budget deficits, he said.

The risk for Trichet is that a refusal to act will see contagion worsen in Portugal and Spain, intensifying speculation they will be forced to follow Greece and seek an international bailout. Australia’s Prime Minister Kevin Rudd said markets have judged Europe’s efforts to help Greece “to be inadequate” and a lack of confidence is spreading to other economies in the region.

“Today’s price action is a call to arms for the central bankers that we hope they hear,” said Stuart Thomson, who helps manage the equivalent of about $100 billion at Ignis Asset Management in Glasgow. “This isn’t the end of the story.”

The extra yield that investors demand to hold Spanish and Portuguese debt yesterday rose to the highest level since the euro’s inception in 1999. The premium on Spain’s 10-year government bonds over German bunds hit 166 basis points.

Euro Slides

In currency markets, the euro fell as low as $1.2529, taking its slide against the dollar since late November to 16 percent. It traded at $1.2692 as of 12:42 p.m. in Tokyo after Japanese Finance Minister Naoto Kan said the Group of Seven will hold a conference call today to discuss Greece’s fiscal woes.

Asian stocks opened lower today, with the Nikkei 225 Stock Average tumbling 3 percent in Tokyo after a 3.3 percent drop yesterday. Australia’s S&P/ASX 200 Index lost 2.2 percent. The Dow average, which at one point plunged the most since the 1987 crash, dropped 3.2 percent, and Brazil’s Bovespa stock index fell to a three-month low.

Markets will continue to test the resolve of policy makers by selling the euro and bonds of high-deficit economies, said Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. in New York. “In sword fighting it is said if you feel mush, push,” he said. “The market feels mush.”

Trichet is trying to convince investors that turmoil in euro-region markets will subside once the Greek government draws on its 110 billion-euro ($140 billion) aid package and implements an austerity plan. He urged other European governments to take “decisive” action on deficits.

Pressure on ECB

“They see this as a political problem and are looking to the politicians to provide a lead, but the point at which the ECB can do nothing and let markets heal themselves is ending,” said Thomson.

Rudd, the Australian prime minister, said “markets have judged those arrangements to be inadequate,” referring to the package for Greece in an interview on 3AW radio from Melbourne today. “The problem that’s come from that is that it’s spread a broader lack of confidence into market perceptions of a range of other economies in Europe,” he said.

Germany, which will provide the biggest share of Europe’s bilateral loans to Greece, will vote on its contribution today. Euro-area leaders will then meet later in Brussels to sign off on the aid package, which is being co-financed by the International Monetary Fund.

Deadly Protests

Greece’s parliament yesterday approved the austerity measures demanded in return for the bailout amid public unrest. Three people died in a fire in Athens on May 5 set by protesters during a general strike against wage cuts and tax increases.

Investors are concerned that Greece, which had its credit rating cut to junk by Standard & Poor’s last week, won’t be able to make the budget cuts demanded of it and could default on its debts, a fear that is spreading to Europe’s other indebted nations. Moody’s Investors Service put its Aa2 credit rating on Portugal on review for a possible downgrade this week.

Trichet’s stance yesterday was “reminiscent of the one we saw during the credit crisis,” when the ECB refused to follow the U.S. Federal Reserve and the Bank of England to buy government bonds, said Nick Kounis, chief European economist at Fortis Bank in Amsterdam.

If the crisis persists, the ECB “will probably bring back its full array of liquidity-providing operations” such as unlimited long-term loans to banks, said Kounis. “However, we doubt that the central bank will go into the government-bond buying business.”

Bond Purchases

While the ECB cannot buy government bonds directly, it could do so in the secondary market. The concern is that directly financing national deficits runs counter to the ECB’s founding treaty and could also fan inflation, the containment of which is the ECB’s main mandate.

Floating a proposal to buy government debt could lead to a split on the ECB’s Governing Council, said Carsten Brzeski, an economist at ING Group in Brussels.

“I can’t see that Germany would accept it,” he said. “It’s questionable whether the purchase of government bonds would have any positive effect and as long as you can’t guarantee the success, you have to ask whether it’s worth breaking the spirit of the Maastricht Treaty.”

Germany’s Axel Weber said May 5 that the threat of a spreading crisis doesn’t merit “using every means.”

‘Nuclear Button’

Trichet “did not explicitly rule out bond buying, rather just replied that it was not discussed today,” said Christoph Rieger, co-head of fixed-income strategy at Commerzbank AG in Frankfurt. “This approach can be considered consistent with the ECB’s principles. But it risks that the market will still force the ECB’s hand before long.”

Should further steps be needed, the ECB may take them May 20, when its council meets for a regular mid-month meeting that isn’t followed by a press conference, said Christel Aranda- Hassel, an economist at Credit Suisse Group AG in London. “If the market seizes up, the ECB is likely to implement further unconventional measures,” she said.

Trichet made clear yesterday that the ECB always takes the appropriate decisions, even if they’re not conventional, said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London.

“That suggests some flexibility,” he said. “Should contagion take on a new dimension, the ECB will be forced to press the nuclear button and buy government bonds.”