European Central Bank president Mario Draghi must back up his pledge to do what it takes to protect the euro when the bank's policymakers meet on Thursday or else face deep disappointment from investors hungry for - and expecting - immediate action.
In his boldest comments to date, Mr Draghi said last week that, within its mandate, the ECB was ready to do whatever it takes to preserve the euro, fuelling expectation the bank could revive its bond purchase programme as it did a year ago when it started buying the government debt of Spain and Italy.
The talk has already lowered Italian and Spanish bond yields, and the extent to which markets are now primed for a move on Thursday was clearly spelt out in a Reuters poll.
Nineteen out of 24 money market traders said they expect the ECB to restart its mothballed bond-buying programme with purchases of Spanish and Italian debt, with 10 out of 19 expecting it to be announced on Thursday.
But such a step is far from certain, and the ECB may hold off to intervene in tandem with the euro zone's EFSF rescue fund.
Instead, the ECB could explore new policy tools such as outright asset purchases, or quantitative easing, which Britain, the United States and Japan are using to stimulate growth.
There have also been recent suggestions that it could empower national central banks to broaden their asset buying abilities.
The ECB is under intense pressure from within and outside the euro zone to intervene and bring those governments' soaring borrowing costs under control as the debt crisis deepens and increasingly poses a risk to the global economy.
Reflecting the increased tension, US treasury secretary Timothy Geithner flew today to Germany, the euro zone's biggest economy and key to any euro rescue plan, and met Germany's finance minister Wolfgang Schaeuble.
After their meeting, on a remote North Sea island where Mr Schaeuble interrupted a holiday, they issued a statement saying they were optimistic about reform efforts in the euro zone.
Mr Geithner later met Mr Draghi in Frankfurt, but he left that meeting without comment, and no statement was issued.
The ECB chief will also meet Bundesbank president Jens Weidmann, a strong opponent of the ECB's government bond purchase programme, ahead of Thursday's ECB meeting, a central bank source said.
The prospect of a stronger ECB crisis response drove Italy's 10-year funding costs below 6 per cent for the first time since April at an auction today, but fresh turmoil is likely if Mr Draghi fails to convince investors on Thursday.
The August meeting usually draws little attention and in fact the ECB used to skip the summer month's meeting until 2006 - the last year in which it took policy action in August.
The ECB has resisted so far stepping up its action for fear of taking away incentives for governments to implement tough reforms.
Jean-Claude Juncker, head of the Eurogroup of euro zone finance ministers, said yesterday euro zone leaders would work with the ECB to stabilise the euro.
The euro zone rescue fund could, for example, buy government bonds on the primary market, flanked by ECB purchases on the secondary market, media reports said last week.
That way, any intervention would only come under certain conditions.
The ECB would like Europe's permanent ESM bailout fund to take over the bond purchases completely, but its limited size could make its intervention less effective.
One idea, favoured by France, is to give the ESM access to ECB funding with a banking licence. Austrian policymaker Ewald Nowotny said last week such a step had merits - breaking ranks with colleagues.
Another cut in interest rates seems less likely as the ECB assesses the impact of its July rate cut to a new record low at 0.75 per cent. At that meeting, the bank also decided to stop paying banks interest on their overnight deposits with it.
Mr Draghi's remarks last Thursday left many in the market wondering whether his message had been intended and if so how far the ECB would be prepared to go.
Mr Draghi's candid remarks took some of his fellow Governing Council members by surprise, having not agreed with them before hand on the message he would send. This has prompted concerns Mr Draghi may have raised false hopes in the market.
"Nothing new has been discussed (on action ECB could take), but Draghi is not a man to make comments lightly and at the end of the day he is the one calling the shots," said a euro zone central bank source.
"There was always going to be a time when Draghi decided he had to act."
Another source said Mr Draghi was not flagging an imminent move, and any action would likely come only in September or October, in conjunction with euro zone governments, and with a request from Spain for a bailout programme, which Madrid was still trying to avoid.
Reuters
