The European Central Bank headquarters in Frankfurt is where policymakers agreed yesterday to a plan to buy bonds of struggling countries. Photo: Reuters

Matthew Brockett Frankfurt

EUROPEAN Central Bank (ECB) president Mario Draghi said yesterday that policymakers had agreed to an unlimited bond purchase programme to regain control of interest rates in the euro zone and fight speculation of a currency breakup.

The programme “will enable us to address severe distortions in government bond markets, which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro”, Draghi said in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent.

“Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”

Draghi has staked his credibility on the bond plan, telling legislators in Brussels this week that the ECB needed to wrest back control of rates in a fragmented economy and save the single currency. Now it is up to governments such as Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund – the European Financial Stability Facility (EFSF) and the future European Stability Mechanism (ESM) – and signing up to conditions.

“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist, with strict and effective conditionality,” Draghi said.

The ECB reserved the right to terminate bond purchases if governments did not fulfil their part of the bargain, he added.

The ECB would target government bonds with maturities of one to three years, including longer-dated debt that had a residual maturity of that length, Draghi said. Purchases would be fully sterilised, meaning that the overall impact on the money supply would be neutral, and the ECB would not have seniority, he added.

The euro fell as Draghi spoke, easing to $1.2586 against the dollar from $1.2644.

The yield on Spain’s two-year government bond fell to 3.05 percent while Italy’s two-year rate was 8 basis points lower at 2.36 percent.

The ECB has been at the front of fighting the debt crisis, which has driven the 17-nation euro economy into recession.

The central bank yesterday forecast that euro area gross domestic product would drop 0.4 percent this year instead of 0.1 percent, and in 2013, the economy would expand 0.5 percent rather than the 1 percent forecast in June. – Bloomberg