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All eyes on Draghi's bond rescue plan for Europe

FRANKFURT, Germany — European Central Bank president Mario Draghi gets another chance today to spell out how the bank intends to rescue the 17 countries that use the euro from financial disaster.

Expectations have been high since late July when the ECB head vowed to do "whatever it takes" to hold the eurozone together. The following week, on Aug. 2, Draghi announced the broad outlines of a plan to buy short-term government bonds to help out eurozone countries struggling to manage their debt.

Until then, countries such as Spain and Italy had seen their borrowing costs — reflected in the interest rates on bonds they sell — rise to unmanageable levels. Investors were worried the two countries could soon get to a point where they couldn't afford to handle their finances and be pushed into asking for a bailout, which had already happened with Greece, Ireland and Portugal. The worry is that Spain and Italy are too big to bail out. If those countries fail to pay their debts on time, it could spark a financial crisis that could see the eurozone break up, spreading turmoil throughout the global economy.

Here is a look at what Draghi and the ECB have been working on and what to look out for today:

BOND-BUYING STRATEGIES: By buying bonds on the open market — Draghi has said the ECB will target short bonds such as those with maturities of one, two or three years — the ECB can drive up the prices for a country's bonds. That brings down their interest rate — or yield — and makes it less expensive for countries to borrow money. The ECB theoretically has no limit on the money it can use for its bond-buying plan. As a central bank, it can "print money" to pay for the bonds by simply adding to banks' reserve accounts.

How much it spends on bonds sends a message to the markets. Too much and it could be criticized for violating the EU treaty provision that forbids it from financing governments directly. Too little and investors think that ECB is only half-heartedly attempting to solve the eurozone's problems.

Analysts think the ECB will avoid an option suggested by some: setting a firm interest rate ceiling. Once a country's yields hit a certain point, it would step in and buy the bonds. That would send a clear signal to markets but would also tie the bank's hands, forcing it to defend that red line or lose credibility.

POTENTIAL PITFALLS: Draghi has to make sure that the ECB's 23-member governing council is on his side. The bond plan still needs to be passed at the bank's policy-setting meeting by a majority, although but a broad consensus would be preferred. One voice critical of the bond plan belongs to Germany's central Bundesbank — an influential member of the council because of the size of Germany's financial commitment to the eurozone. Its head, Jens Weidmann, has warned that governments could become addicted to the help and avoid making unpopular spending cuts and tax increases to get their debts under control.

"Everyone loves a generous central banker. … There's a tight balancing act here, in which the ECB should provide a safety net, but not give too much away for free," Rabobank analyst Jan Lambregts wrote in a note to investors.

WHAT TO EXPECT TODAY: The only thing that's certain is that analysts and politicians will pore over every word uttered by Draghi.

Rather than giving detailed plans about how the ECB is ready to start bond buying, Draghi is more likely give politicians another stern warning that they'll have to abide by strict conditions if they want help. The pressure will be put back on leaders such as Spain's Prime Minister Mariano Rajoy and Italy's Premier Mario Monti to act first. Only after governments have applied to the eurozone's emergency bailout funds for help will the ECB get going with its bond buying.

All eyes on Draghi's bond rescue plan for Europe 09/05/12 [Last modified: Wednesday, September 5, 2012 8:30pm]
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