ECB to hold off bond buying to help Spain

Financial markets are clamouring for the ECB to step up its efforts to fight the two-year crisis by buying the sovereign bonds of Spain, which is in recession and is struggling to convince some of its people of the need for further austerity.

But ECB policymakers, who will face demonstrators protesting against Spain's harsh austerity measures in the Catalonian capital, are more likely to pay homage to the country's drive to cut costs than to signal any new policy action like restarting the bond-buy programme, or Securities Markets Programme (SMP).

The bank has left the plan dormant for the last seven weeks despite a rise in Spanish yields to 6%. A break above that, to 7%, is considered an unsustainable price to pay for refinancing its debt.

The ECB will almost certainly leave its main interest rate on hold at a record low of 1%, though markets will be listening for any hint that the bank could be ready to cut later this year if the euro zone economy deteriorates further.

ECB President Mario Draghi faces resistance from Germany's powerful Bundesbank to any potential interest rate cut or a reactivation of the bond-buy programme, which the central bank could use to lower Spanish bond yields.

Bundesbank chief Jens Weidmann told Reuters last month Spain should take the rise in its bond yields as a spur to tackle the root causes of its debt woes and not look to the ECB to help by buying its bonds.

GROWTH DEBATE

With Spain sinking into recession in the first quarter, much attention at Draghi's post-meeting news conference will focus on what more the ECB might do to promote growth.

Spain and its problems are at the heart of a downturn in euro zone confidence. Protests at the ECB's tough stance toward struggling euro zone countries are expected outside the meeting in Barcelona and officials have stepped up security.

The frustration stems from tough austerity measures Spain is pursuing to shape up its public finances and a grim economic picture, which is affecting the broader currency bloc.

Preliminary euro zone purchasing managers' (PMI) data released last week – and since confirmed – showed the euro area's private sector slump deepened in April at a faster pace than any economist polled by Reuters predicted, dampening hopes the region will emerge from recession soon.

The prospect of the euro zone as a whole following Britain into recession has set markets wondering whether the ECB could pave the way for a rate cut later this year. It has never before lowered its main rate below 1%.

Draghi said last week any "exit strategy" from the ECB's emergency measures – long-term lending operations and the dormant bond plan – was premature given weak economic conditions and he has not ruled out cutting rates below 1%.

ECB Vice President Vitor Constancio said after the publication of the PMI data there were "very significant" risks to the economy, adding the bank would adapt its policy if those risks became a reality, as it did when it cut rates last year.

If that view makes it into the ECB policy statement that all 23 of the bank's policymakers agree at their meeting, rate cut expectations that have begun to creep back into market pricing in recent weeks are likely to firm rapidly.

Draghi helped shift the tone of the economic policy debate in the euro zone last week when he advocated a "growth compact" without spelling out exactly what he meant.

French presidential candidate Francois Hollande, who wants to step away from German-inspired austerity, has welcomed Draghi's comments and the ECB president will be pressed to flesh out his growth vision.

Draghi has so far pressed governments to pursue structural reforms. He is under pressure to limit the ECB's role in generating growth from Weidmann, who wants countries to put their finances in order rather than looking to the central bank.