2 Aug 2012

Stock markets drop as ECB dashes traders’ expectations

Stock markets plunged and the cost of borrowing in Spain and Italy went up as the European Central Bank President Mario Draghi disappointed markets with a non-committal press conference.

Traders had been lured into believing that more decisive action from the ECB was on the cards after Mr Draghi told a press conference in London last week: “the ECB will do what ever it takes to preserve the euro, and believe me that is enough.”

But even before he had finished speaking, the familiar refrain from Mr Draghi – Europe’s financial situation was getting worse and stronger measures than had yet been agreed would be necessary – saw share prices heading south. The cost of borrowing for Spain rose back over the 7 per cent level and the Spanish stock market fell nearly 5 per cent.

“The ECB disappointed those who had hoped for the Big Bertha to fire immediately,” said Joerg Kraemer, chief economist at Commerzbank. “Instead, the ECB wants the problem countries to first turn to the…bailout fund.”

Traders had earlier warned of the perils of a lack of concrete action:

“If Draghi just comes out with a do-nothing, markets are going to react extremely badly and the ECB will have a full- blown crisis on their hands,” James Nixon, London-based chief European economist at Societe Generale, told Bloomberg. “I can’t see what form of words Draghi can come up with that would replace concrete intervention.”

US, Asia markets down

US and Asian equities fell when the US Federal Reserve on Wednesday failed to offer any fresh measures, monetary stimulus, or outline future moves after admitting the US economy had “decelerated”.

European investors now want to know how their governments and the ECB plan to solve the sovereign debt crisis threatening to bankrupt Greece, cripple Spain and Italy, and bring the 17-nation euro area down with them.

The ECB has several options. It could buy more sovereign debt, allow banks to hold more debt, cut interest rates or give the European bailout fund status to deal directly with banks – although Germany does not support the last plan.

Spanish fears

Fears that Spain will need a full-scale country bailout on top of the 100bn euro banking bailout are leading to speculation that the ECB could announce unprecedented steps today. Spain’s 10-year yield recently hit a record high of 7.6 per cent.

Last week Mr Draghi told an audience in London that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro”.

“Expectations are very high, the markets recognise that past measures simply haven’t worked,” David Llewellyn, vice chairman of the Banking Stakeholder Group at the European Banking Authority, said.

“I think that no matter what they do, they are going to disappoint the market,” Brown Brothers Harriman chief currency strategist Marc Chandler told CNBC. “The policy makers don’t make a decision unless they have to.”

Mr Draghi speaks to the media at 3.30pm BST, an hour before the New York markets open.