FRANKFURT Italy's high borrowing costs are not a big issue in the short term, European Central Bank governing council member Jens Weidmann told the Financial Times, stressing that the onus is on governments to resolve their financing issues and not the ECB.
Italian 10-year bond yields have shot past 7 percent -- the point at which Portugal and Ireland were forced seek bailouts -- despite ECB buying of the country's debt, making it clear that a bigger response is required.
Weidmann, who is also the president of the German Bundesbank, told the Financial Times in an interview that such rates may not be sustainable over the long run if there was a lack of fiscal discipline and growth remained low.
"But in the short run I do not think it is such a big issue. What we are facing in Italy is an acute confidence crisis, and only the Italian government can resolve that crisis by implementing what has been announced," Weidmann said.
"Italy is very different from Greece in a lot of respects. I'm confident that Italy will be able to deliver," he was quoted as saying.
Weidmann said this was not a crisis of the bloc's single currency -- the euro -- but rather a sovereign debt crisis that now showed contagion effects. "For me, the eurozone as a whole is not at stake," he said.
The ECB is under growing pressure from world leaders to do more to address the crisis which has now engulfed Italy and despite the intensification, the ECB has not delivered the kind of 'shock and awe' intervention that could calm markets.
The bank is reluctant to take more risk onto its books by buying more bonds from debt-laden euro zone countries.
Weidmann stressed that it was governments' responsibility to regain investors' trust by implement necessary reforms, calling the debate about the ECB becoming the lender of last resort for the Italian government "absurd."
"This whole debate completely blurs responsibilities," Weidmann said. "Furthermore, monetary financing will set the wrong incentives, neglect the root causes of the problem, violate the legal foundations on which we work, and destroy the credibility and trust in institutions," he added.
"You won't solve the crisis by reducing incentives for the Italian government to act. It's really an absurd debate in which we are telling institutions: don't care about the law," Weidmann said.
The case of Italy had shown "quite clearly" that "market interest rates do play a role in pushing governments toward reforms," Weidmann added.
THINLY VEILED MONETARY FINANCING
With the euro zone's rescue fund not ready for deployment until December at the soonest, markets are looking to the ECB to intervene on a greater scale with its bond-purchase program, which has so far totaled 183 billion euros.
Weidmann said the purpose of the ECB's government bond purchases was to cope with dysfunctional markets and was not to ensure a specific spread for a specific country, which would compromise its mandate of ensuring price stability and put its independence at risk.
Asked whether the Italian bond market was currently dysfunctional, Weidmann said: "What we see is a reaction to the political problems in Italy and the lack of implementation and I wouldn't consider that as dysfunctional."
Euro zone countries had hoped to increase the European Financial Stability Facility's (EFSF) lending capacity by December, combining bond insurance with investment vehicles.
Weidmann said recent talk about using gold and currency reserves or IMF special drawing rights to boost the euro zone bailout fund was against the ECB's mandate.
"Using foreign reserves as capital of an SPV (special purpose vehicle) whose only purpose of is to fund governments is just a thinly veiled form of monetary financing," he said.
Weidmann added that the plan agreed in Brussels late last month to lure investors, who have shunned bonds issued by highly indebted euro zone countries, back by offering insurance on bond losses, had been put into question by the recent agreement of banks and other bondholders to volunteer for a 50 percent cut in the value of Greek sovereign debt.
"I think the insurance model has been put into question by the recent decisions on the private sector involvement (PSI)," Weidmann said.
Asked whether it had been a mistake to change the PSI terms in October, Weidmann said: "One of the effects of the renegotiation of the PSI is that the perception of sovereign risk in the market has further changed ... So at least for some countries, the risk profile of their sovereign bond markets has deteriorated."
The ECB cut interest rates 25 basis points to 1.25 percent in November, saying the euro zone could subside into a "mild recession" in the latter part of 2011.