UPDATE 2-ECB chief Draghi says risks have worsened again

Thu Dec 1, 2011 7:56am EST

Related Topics

* Says ECB price stability goal applies in both directions

* Says Downside risks to economic outlook have increased

* Presses govts to agree tougher fiscal rules

* Says "other elements might follow", hinting at possible ECB action

By John O'Donnell

BRUSSELS, Dec 1 (Reuters) - The new president of the European Central Bank signaled on Thursday it is ready to take fresh steps to tackle the euro zone debt crisis, saying risks to the economy have grown and banking sector constraints bode ill for the coming months.

Highlighting action the ECB and other central banks took on Wednesday to provide dollar liquidity, Mario Draghi - a month into his presidency - said the bank aimed to ensure inflation did not undershoot or exceed its target of just below 2 percent.

Markets read that and the warning of growing downside risks to the economic outlook as pointing to a second cut in official interest rates in as many months at next week's ECB policy meeting, pushing the euro to a session low.

"The ECB's monetary policy is constantly guided by the goal of maintaining price stability in the euro area over the medium term -- and this applies to price stability in both directions," Draghi told the European Parliament.

"Downside risks to the economic outlook have increased."

Draghi stressed that he was speaking in the ECB's pre-meeting period and that nothing he said should be interpreted in terms of future policy decisions.

But many investors read the comments as raising the chances for a rate cut next week over which analysts have been divided. The bank cut rate last month to 1.25 percent.

"These comments do open up the chance for a rate cut," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"Next week we will have the ECB staff forecasts and we will surely get a substantial downgrade to growth and inflation forecasts. All of which will lead to expectations of a rate cut by the ECB and extension of non-standard measures. The markets will be very frustrated if they don't get that next week."

FISCAL COMPACT

Draghi also pressed euro zone governments to adopt a "new fiscal compact" -- an agreement on tighter budget rules that he said would help restore financial markets' confidence in the currency bloc.

"Other elements might follow, but the sequencing matters," he said, suggesting the ECB could do more if governments move first on budget rules. "It is first and foremost important to get a commonly shared fiscal compact right."

"I think the next few days will be very important to tell us whether we make progress on this," he later added, pressing EU leaders to reach an agreement at a crucial summit they are holding on Dec 9.

Germany and France have promised to come up with proposals for greater fiscal integration of the euro zone for a summit on Dec. 9, a day after the ECB next meets.

By saying "other elements might follow", Draghi appeared to be leaving open the possibility of a bigger ECB role in tackling the crisis, which has seen investors flee the euro zone bond market, fuelling doubts about the survival of the euro currency.

The ECB has so far resisted political pressure from some countries to ramp up its bond purchase programme (SMP) to relieve pressure on those governments embroiled in the crisis.

"In his remarks concerning the SMP, Mr Draghi appeared implicitly to hold up the offer of a significantly higher pace of debt purchases under the SMP and potentially other measures, provided that euro area governments were to commit to a new fiscal pact," Callow wrote in a research note.

Draghi said the bond purchase plan was a means "to repair monetary transmission channels", adding that: "In our view now the most important thing for the ECB to do is to repair the credit channel."

An ECB survey released separately on Thursday showed small and medium-sized businesses in the euro zone expect their access to bank loans to worsen in the near future.

Although it was the first time Draghi addressed a full sitting or so-called plenary session of the European Parliament, only a handful of its 736 lawmakers turned up to listen or ask him a question.

For those who were present, Draghi delivered a sobering message on the economic outlook: "We have observed serious credit tightening in the most recent period, which combined with the weakening of the business cycle, doesn't bode at all well for the months to come," he said.

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