OPINION: The institution has little choice but to intervene in the bond markets, writes QUENTIN PEELin Berlin

WHEN GERMAN chancellor Angela Merkel and French president Nicolas Sarkozy issued a joint communique on Sunday evening, it was not immediately apparent why they had done it.

It came in the middle of the critical conference call involving the governing council of the European Central Bank. The central bank governors were set to give their grudging approval to buying the bonds of Italy and Spain, to prevent two core members of the euro zone facing a disastrous increase in their borrowing costs.

That was the only decision that mattered on Sunday night, to the financial markets, and to the future of the common currency.

The Franco-German message seemed superfluous: the two leaders repeated what they had already decided at the euro-zone summit on July 21st, including reforms to expand the powers of the European Financial Stability Facility (EFSF), the €440 billion euro-zone rescue fund.

But the message contained two more subtle signals: one was a blunt response to European Commission president José Manuel Barroso that his call last week to give more money to the stability facility was out of order. France and Germany would implement exactly what they had agreed, no more.

The other was a ringing vote of confidence in the ECB. “In line with the July 21 decisions, France and Germany are confident that the ECB analysis will provide the appropriate basis for secondary market interventions as it will help determine the case when financial stability of the euro zone as a whole is at risk.”

The ECB was the one institution that could define a threat to the common currency, and also provide its last line of defence, they said. It was the euro’s crisis manager. And Merkel was giving a green light to ECB bond-buying, even though the German Bundesbank, headed by her former economic adviser Jens Weidmann, was firmly opposed.

German critics, including most of the economic establishment, argue that intervention in the Italian and Spanish bond markets is not an act of pure monetary policy. They say it is a political act, not a technical one.

Jean-Claude Trichet, the outgoing president of the ECB, has long made clear that he feels deeply uncomfortable in the role, but sees no immediate alternative.

He has made himself unpopular by repeatedly lecturing European leaders on the need for them to enforce more fiscal discipline and provide a safety net for crisis resolution. That is supposed to be the EFSF rescue fund.

“The ECB would become a political institution if it had to take this [bond buying] as a permanent role,” says Jean Pisani-Ferry, director of the Brussels-based think tank Bruegel. “That is why ratification of the new powers for the EFSF is so important.”

Trichet’s statement on Sunday made clear the ECB considered its new round of bond purchases to be a temporary bridge until the EFSF was revamped and ready to buy bonds itself. That process is supposed to be finished by the end of September.

It is not a foregone conclusion. Merkel will face a tough political battle in Berlin to persuade the Bundestag that a fund that gets at least 30 per cent of its financial guarantees from the German taxpayer will be allowed to buy the bonds of other euro-zone governments, and provide “precautionary” loans when they have liquidity problems. There is strong resistance in the Dutch and Finnish parliaments too.

“We want something that is nimble and flexible, but [the EFSF] will require all sorts of authorisations before it starts moving,” says Pisani-Ferry.

The EFSF – and the European Stability Mechanism that will succeed it from 2014 – is only one part of the euro zone’s future management system, which includes much closer co-ordination and surveillance of economic and fiscal policies.

The euro-zone crisis has driven its 17 member states to ever-closer integration. It has also left the commission weaker. Barroso’s untimely letter last week demonstrated that he was no longer a central influence in the euro-zone crisis, according to officials in Berlin.

Daniel Gros, director of the Centre for European Policy Studies, formerly proposed a European monetary fund with its strategic direction set by member states, but the implementation decided by the staff. He fears that the EFSF will not only be cumbersome, but also – as Barroso suggested – too small.

“The EFSF is big enough for the smaller states. For Spain and Italy it has to be the ECB,” Gros says. “The EFSF cannot do it because it is not large enough.”

The ECB may not cherish the role, but it will remain at the heart of crisis management in the euro zone. – (Copyright The Financial Times Limited 2011)