Bundesbank holds firm in opposition to ECB bond buying

BERLIN/FRANKFURT (Reuters) - Germany's Bundesbank on Monday stepped up its resistance to a European Central Bank plan to buy billions of euros worth of Spanish and Italian government bonds to reduce those countries' crippling borrowing costs.

The ECB is being forced to take a greater role in fighting the euro zone crisis while the bloc's governments negotiate legal and political hurdles to coordinating a longer-term response, but the Bundesbank wants to limit central bank action.

The ECB sought to quash speculation about the form of the new bond-buying plans as the Bundesbank kept up its opposition, even after German Chancellor Angela Merkel voiced support for the ECB's crisis-fighting strategy last week.

The powerful Bundesbank, the central bank of Europe's largest economy, objects to ECB President Mario Draghi's plan to resume buying bonds on the grounds that this amounts to monetary financing of governments, contravening European law.

"The Bundesbank remains critical of the purchase of euro system sovereign bonds, which comes with considerable risks for stability," the Bundesbank said in the introduction of its monthly report, reflecting the views of its leadership.

"Decisions about a possible broader mutualisation of solvency risks should be ... with the governments and parliaments, and should not occur via central bank balances."

The Bundesbank retains substantial influence within Germany and on financial markets due to its inflation-fighting credentials but, as just one of 17 constituents at the ECB, it is unlikely it could scupper Draghi's plan.

The euro fell after publication of the report [ID:nL2E8JK2OB], which came on Bundesbank chief Jens Weidmann's first day back at work following his summer holiday.

Policymakers are posturing over the program ahead of a crunch ECB meeting on September 6, at which markets will be looking for the central bank to spell out more details of the plan.

In Italy, Industry Minister Corrado Passera said Bundesbank criticism of the ECB plans "does not honor those who make them." He said there had recently been an excess of "incoherent and disruptive communications which have also disturbed markets."

Draghi, an Italian, indicated earlier this month the ECB could intervene in debt markets but he held back from announcing concrete steps.

ECB LID ON BOND "CAP" TALK

The ECB said that it was misleading to talk about decisions not yet taken on the shape of the program.

Over the weekend, German magazine Der Spiegel said the ECB was considering buying struggling euro zone country's bonds if their borrowing costs exceeded a certain premium over Germany's, prompting an angry response from the ECB.

"It is absolutely misleading to report on decisions, which have not yet been taken and also on individual views, which have not yet been discussed by the ECB's Governing Council, which will act strictly within its mandate," an ECB spokesman said.

"As far as recent statements by government officials are concerned, it is also wrong to speculate on the shape of future ECB interventions. Monetary policy is independent and undertaken strictly within the ECB mandate," he added in a statement to journalists.

A Reuters poll of economists conducted last week showed most did not expect the ECB to set a cap on Italian and Spanish bond yields.

The ECB is still drawing up the new bond plan, which will be distinct from the dormant Securities Markets Programme - the first wave of buying it began in May 2010 and over which the last Bundesbank chief, Axel Weber, quit in protest.

As a pre-requisite for any ECB bond buying to help a troubled euro zone state, the central bank wants the government concerned to request aid from the bloc's bailout funds and to fulfill the economic conditions attached to any help.

Last week, Merkel offered a robust defense of Draghi, after he triggered a stormy debate in Germany by promising to do "whatever it takes to preserve the euro" and signaling his readiness to resume ECB bond purchases.

However, one central bank source said there is still disagreement within the ECB over the terms of the scheme.

Spain's economy minister Luis de Guindos said in comments published on Saturday that the ECB must take forceful and unlimited steps to buy sovereign debt to help Spain reduce its funding costs and eliminate doubts over the euro zone's future.

But other European countries will want to ensure Spain does not start to soft-pedal its reforms - as Italy did last year when the ECB began buying its bonds - and signs the euro zone crisis is affecting the bloc's core will stiffen their resolve.

ECONOMIC GLOOM

The Bundesbank said Germany's economy, which has remained resilient through most of the euro zone crisis and posted solid growth, could suffer more in the second half of this year.

Companies were already "considerably more gloomy" about their business prospects, and had been investing less for three quarters of a year as exports to the currency bloc sagged, the Bundesbank said.

While the economy put in a strong performance in the first three months of this year, growth slowed to 0.3 percent in the second quarter and recent data have shown manufacturing orders, industrial output, imports and exports all dropping.

The Bundesbank warned the government should not delay budget consolidation or be overly optimistic about its room to maneuver on spending.

"The trust in German state finances is an important stabilizing factor in the current crisis but is not unshakeable," the Bundesbank wrote.

(Additional reporting by Sakari Suoninen in Frankfurt, and Michelle Martin and Madeline Chambers in Berlin, editing by Noah Barkin and Toby Chopra)