Stocks drop as ECB rules out eurozone support

Mario Draghi Mr Draghi played down the chance of the ECB increasing its support for Italy

Stocks have fallen after the European Central Bank ruled out any substantial aid for indebted eurozone states.

The US Dow Jones index closed down 1.6% with the wider Standard and Poor's 500 down 2.1%. French and Italian shares ended down 2.5% and 4.3% respectively.

ECB President Mario Draghi unveiled new support measures for eurozone banks and cut rates to 1%.

It came as the European Banking Authority increased its estimate of the capital shortfall facing EU banks.

"People are very nervous that Europe will yet again fail to adequately address the sovereign debt crisis," said David Kelly, chief market strategist for JP Morgan Funds.

Other markets also fell. Germany's Dax finished 2% lower and the UK's FTSE ended down 1.14%.

There had been speculation that the ECB may be preparing to substantially increase its purchases of Italian sovereign debt if eurozone governments agree tough new limits on their borrowing and on economic reforms.

But Mr Draghi seemingly ruled this out: "We have a treaty that says no monetary financing to governments."

The euro, which had risen following the announcement of the interest rate cut, fell more than a cent against the dollar while Mr Draghi was speaking.

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Propping up banks is also helping to prop up countries, because the ECB is directly or indirectly providing external liquidity to national financial institutions that the markets are no longer willing to provide”

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The moves come ahead of a "do-or-die" Brussels summit of European Union heads to hammer out a deal on how to tackle the eurozone debt crisis, including a potential new treaty.

The two-day EU summit ending is expected to agree tough new rules and automatic fines to ensure that eurozone governments cut their borrowing to below 3% of their GDP.

This week, Standard and Poor's put almost all eurozone countries on "credit watch". It means that six countries with top AAA ratings - including Germany and France - have a 50% chance of seeing their credit ratings downgraded.

New bank aid

Mr Draghi called again for governments to cut their borrowing, and to boost growth by making their labour markets more flexible, and opening up product markets to more competition.

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However, Mr Draghi dismissed the prospect of a eurozone break-up as "quite far-fetched at this stage".

He also praised the efforts of the new Italian government.

Mr Draghi also announced further measures to support the eurozone's banks, including:

  • three-year loans to be available from 21 December
  • more generous minimum standards for what the ECB will accept as collateral on the loans it makes
  • a cut in the reserve ratio - the percentage of a bank's assets that must be held in cash at the central bank - from 2% to 1%.

The ECB president explained the measures were intended to head off a credit crunch affecting companies and mortgage borrowers.

Some banks have increasingly been relying on existing emergency loans from the ECB, as they find it harder to borrow money from markets.

Last week, the ECB joined with the US Federal Reserve, the Bank of England and three other major central banks in announcing an agreement that would ensure that their banks had access to foreign currency emergency loans.

The surprise move sparked speculation that one or more major European banks could be on the point of collapse, because of their inability to borrow in US dollars.

Shortly after the ECB's announcement the European Banking Authority (EBA) said European banks need 114.7bn euros ($154bn, £96.25bn) to be sure of withstanding future financial shocks.

It means banks need to raise 8bn euros more than previously thought - with much of the increase falling on German lenders.

Rate cuts

The central bank again cut its forecast for economic growth in the eurozone next year, to a range of 1% growth to a 0.4% contraction - raising the prospect of a recession.

How is the European Central Bank helping the banks?

The lower forecast may herald further interest rate cuts.

It is the second such rate cut since Mr Draghi took over the ECB presidency last month.

The first rate cut, only days after he took over, reversed the central bank's policy direction. Under his predecessor, Jean-Claude Trichet, the ECB had begun raising rates over the summer to ward off higher inflation.

The second cut has returned rates to the record low 1% level that prevailed from the summer of 2009 to the end of 2010, in response to the global financial crisis and recession.

Mr Draghi confirmed that the decision was not made unanimously.

The ECB gas been providing some support to Italy and Spain, by buying up their debts in the financial markets to push down the cost of borrowing.

Italy's 10-year cost of borrowing had risen above the 7% level widely deemed to be unsustainably expensive, but fell back below 6% in recent days, in expectation of ECB aid.

Following Mr Draghi's press conference, it rose back above 6%.

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