Published: 4 December 2011 - The Sunday Times - UK

Angela Merkel is ready to sanction a bigger role for the European Central Bank in exchange for a deal on closer fiscal union

A €1 trillion cash injection for the troubled eurozone economy is being prepared by the European Central Bank ahead of a series of key crisis summits this week.

Mario Draghi, the new president of the ECB, is said to be working on a plan this weekend which would pave the way for a colossal market intervention in European sovereign bonds.

The plan would only be executed if Europe’s leaders reach agreement on a broader political reform of the currency bloc — imposing strict budget controls on nations struggling to control their state finances.

Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, are due to meet in Paris tomorrow ahead of a European Union summit in Brussels on Friday.

Details of an expanded role for the ECB in controlling the crisis could be unveiled at its rate-setting meeting on Thursday.

It is understood that the ECB is willing to more than double its existing bond-buying efforts if it is protected from any possible losses. A plan has been discussed that would see Europe’s bailout fund, the European Financial Stability Facility, insure the central bank against losses from the bonds.

Some of the cash could come from the International Monetary Fund (IMF), which is said to be willing to provide about €200 billion (£170 billion) to help resolve the crisis.

The ECB’s role would be restricted to stabilising prices in Europe’s bond markets — preventing the yields on Spanish or Italian debt from spiralling out of control.

The intervention would be presented as a stop-gap measure to ease market pressures while the eurozone transitions towards closer fiscal union.

Although Merkel has previously resisted an increased role for the ECB, she is said to be willing to accept a ramped-up bond-buying programme on these terms.

Economists warn that Britain faces a grim outlook even if a euro deal is cobbled together, and a dramatic and sustained downturn if the euro is allowed to disintegrate.

Economists at Price Waterhouse Coopers, analysing last week’s forecast from the Office for Budget Responsibility (OBR), say it implies a prolonged squeeze on consumer spending such as never seen before in the post-war period.

In the 10 years to 2014, spending per person will fall by an average of 0.2% a year, the previous low having been a 1.3% average rise in the 10 years to 1983.

“The squeeze on consumers — and so on those selling to consumers — is quite unprecedented in post-war history,” said John Hawksworth, chief UK economist at PWC. “Given that consumer spending data only goes back to 1948 it is not possible to say if there was ever such a severe real consumer squeeze before that.”

Capital Economics warned that the new credit crunch facing the economy will mean outright recession in 2012, with a 0.5% drop in gross domestic product, followed by growth of just 0.5% in 2013.

“The OBR and Bank of England have revised down their forecasts but they still look optimistic to us,” said Jonathan Loynes of Capital Economics.