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Will Mario Draghi and the ECB deliver?

August 1, 2012: 3:48 PM ET

After the Federal Reserve declined to spike the punchbowl Wednesday, fans of monetary stimulus are now entirely dependent on the European Central Bank for a fix.

In leaving its policies unchanged, the Fed gave investors what they expected, but not what they wanted. Now, all eyes are turning to Frankfurt, where top ECB officials will meet Thursday for their monthly policy discussion.

ECB president Mario Draghi raised the stakes last week when he said the ECB will do "whatever it takes" to preserve the euro currency. In a coda that caught the attention of many stimulus-hungry investors, Draghi added: "Believe me, it will be enough."

But investors who think that Draghi is going to do something big and bold as soon as Thursday morning are much more likely to be let down if he fails to deliver. Beware, this could end in tears.

"We think there is plenty of scope for disappointment," said John Higgins, senior market economist at Capital Economics. "The ECB's bark could prove louder than its bite."

Granted, Draghi sent a strong signal last week that the ECB would intervene in the bond market to ease borrowing costs for Spain and Italy.

Draghi appeared to argue that buying bonds would fall under the ECB's mandate. But it may not be that simple.

The Bundesbank, Germany's powerful central bank, quickly reiterated its opposition to additional bond buying under the ECB's controversial Securities Market Program, or SMP.

While German Chancellor Angela Merkel has warmed to the idea, Bundesbank president Jens Weidmann could still vote against intervening in the bond market, said Holdger Schmieding, chief economist at Berenberg Bank.

Related: Spain on the brink

That wouldn't necessarily prevent the ECB from pushing ahead, but it could give investors reason to doubt the bank's resolve.

"Once again, the Bundesbank would undermine the ECB," said Schmieding.

As an alternative, analysts say eurozone leaders could use funds from the European Financial Stability Facility to buy bonds directly from governments in the primary market, while the ECB intervenes in the secondary market. But Tobias Blattner, a former ECB economist who is now at Daiwa Capital Markets, noted that Spain and Italy have not made any requests to sell bonds to the EFSF.

Under another proposal, the ECB would set a cap on bond yields or limit the spreads between yields on Spanish and Italian bonds versus the German benchmark. This approach, which is similar to steps the Swiss National Bank has taken to support the franc, would help eliminate doubts about the ECB's commitment, according to Schmieding. "The ECB might not have to actually buy many bonds," he said.

There is also speculation that the European Stability Mechanism, a bailout fund that has yet to be fully established, could be given a banking license. In theory, this would allow the ESM to borrow money from the ECB, effectively giving it a source of unlimited funding to buy bonds.

But this is "highly unlikely" given that the ESM from barred from becoming a counterparty of the ECB under current statutes, according to Blattner.

Blattner said the most likely outcome is that the ECB will offer European banks another round of ultra low cost financing by launching a third Long-Term Refinancing Operation, or LTRO. A third LTRO is "the very least market participants are looking for from Thursday's meeting," said Blattner. "There has always been a broad majority in the ECB's governing council in support of liquidity measures for solvent banks."

The ECB funneled more than €1 trillion into the banking system in two previous LTROs, which temporarily drove down sovereign borrowing costs earlier this year.

Related: IMF calls for action as euro crisis escalates

However, critics say providing additional liquidity would only reinforce the unhealthy co-dependence between banks and governments, in which banks are the main buyers of domestic sovereign debt only because they are receiving cheap ECB financing.

In addition to this so-called doom loop, a third LTRO also raises questions of moral hazard. Draghi has repeatedly argued that the ECB cannot solve the underlying problems in the eurozone, which he says must be addressed by government leaders. The concern is that ECB intervention would remove the incentive government policy makers have to implement unpopular reforms.

Sound familiar? Fed chairman Ben Bernanke is pretty much saying the same thing about Congress and the upcoming fiscal cliff. It's good to see central bankers sticking together.

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Ben Rooney
Ben Rooney
Staff writer, CNNMoney

Ben Rooney is a staff writer for CNNMoney. He covers the European debt crisis and other international finance stories, in addition to writing about stocks, bonds, investing and other Wall Street-related news. Follow Ben on Twitter: @ben_rooney

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