LONDON (Reuters) - Mario Draghi has set a high bar by declaring that his European Central Bank will do whatever it takes within its mandate to preserve the euro.
At the very least, financial markets expect the ECB to overcome the Bundesbank's reservations and resume its Securities Markets Programme (SMP), which it last deployed to buy government bonds in the open market nearly five months ago.
A flavor of what would happen if the central bank did anything less came on Friday, when the euro, European shares and Spanish and Italian bond prices all fell after the Bundesbank reiterated its past criticism of this bond purchase programme.
The ECB will have to be far more aggressive than in the past to win more than a fleeting breathing space for Spain and Italy, whose borrowing costs have surged and whose bailout needs would be too big to be covered by current funds.
To buy politicians enough time to resolve a crisis that poses a growing threat to the euro zone, the central bank needs to purchase as many Spanish and Italian bonds as it takes to convince investors to do the same.
Central banks in the United States, Japan and Britain have already deployed "quantitative easing" (QE) programs, which involve buying large quantities of government bonds or other assets to prod economic activity. That would be controversial for the ECB, which is barred by European law from using its balance sheet to finance government spending.
The ECB's bond buying has so far been different from QE because the bank removes as much money from the financial system as it puts in, a process known as sterilization. Some experts say that to be effective the ECB would have to adopt tactics more closely resembling the full-blown QE seen elsewhere.
"What would really work is for the ECB to make an unlimited and credible promise to spend as much money as needed, to declare caps on bond yield spreads or actual yields, and to give Europe's rescue funds more leverage," said Carsten Brzeski, senior economist at ING in Brussels.
"Unlimited use of the SMP is quantitative easing in my view, but this is all hypothetical. Just the idea would give them stomach pains and it is unlikely to happen. Even if they were willing to do it, there are legal and practical considerations which mean they won't."
There may be divisions within the ECB over how to tackle the crisis but it is viewed by markets as the only institution that can move quickly and effectively enough to halt a rot which is being transmitted across the euro zone via the bond market.
The infection has reached Spain, which is seen as struggling to finance itself for much longer if its 10-year bond yields stay near euro-era highs of 7.78 percent seen this week.
That was a premium of nearly 6.5 percentage points over German bond yields and surpassed 10-year yields on bonds issued by Ireland, which has already taken a bailout.
Moreover, Italy, the euro zone's third biggest economy, is also being sucked into the crisis.
Firing up the ECB's existing bond buying programme would be a start. Even that could annoy Germany's Bundesbank, which is particularly vigilant in opposing suggestions that central bank policy be used to finance countries' spending.
The ECB has bought 211.5 billion euros worth of bonds in total since it started its SMP programme in May 2010. Its biggest weekly spend was 22 billion euros back in August 2011 but it has barely deployed the programme this year.
But while those purchases managed to slow the rise in yields of highly-indebted euro zone countries, they weren't enough to turn the tide then and won't be enough now, analysts said.
"Draghi is putting his personal credibility on the line so my best belief is that if they come in, they won't do it half-heartedly," said Erik Nielsen, global chief economist at UniCredit.
"The reason the SMP did not work in the past was that it was done too timidly and was leaning against the wind amid all the noise from the Bundesbank. It is not clear what it will take to drive (bond yield) spreads down to levels they would consider acceptable but it is certainly not what they did before."
The central bank would therefore have to use new tactics to have any lasting impact and live up to Draghi's promise.
"Full-on QE is the one thing that would make a massive difference and which would be a game changer - nothing else would make a difference at the present time," said Mark Schofield, global head of interest rate strategy at Citi.
"Data has really deteriorated, both in terms of growth in the core and the periphery, and inflation expectations have come off. I think the comments (by Draghi) suggest that the thought of QE will have crossed their minds, even though we might not see it anytime soon."
Financial market analysts say the ECB won't want to act unless it believes governments are doing their homework.
The central bank has always insisted on the need for countries to meet budget promises they make to their euro zone partners and the importance of root and branch reforms that will play a long-term role in helping growth and reducing deficits.
And whatever it does, the ECB will only buy time for governments to address the underlying fiscal problems.
"The ECB's intervention policy has tended to be conditional, so as long as European governments are taking steps they will intervene," Steven Major, global head of fixed income research at HSBC, said.
"Markets are very binary and have struggled to recognize that there is no silver bullet."
Reporting by Swaha Pattanaik; Editing by Peter Graff