FRANKFURT, Germany (AP) -- European Central Bank President Mario Draghi tempered market expectations for aggressive action by the bank to bail out heavily indebted euro countries if they agree to tougher rules on borrowing and spending.
Draghi spoke at a press conference Thursday after the ECB announced modest steps to help revive Europe's economy and financial system, including cutting a key interest rate.
Stocks and the euro fell heavily, while borrowing costs for European governments rose. Bank stocks were particularly hard hit.
Based on comments Draghi made in a speech last week, hopes had been rising on financial markets that the ECB was preparing to ramp up its purchases of European government bonds as the eurozone economy slides toward recession. But on Thursday he said the bank had no explicit plan to do so and was "surprised" by the way his remarks had been interpreted.
Draghi said the notion of the eurozone being broken apart by its worsening debt crisis was "far-fetched" and that confidence in the 17 countries that use the euro would rise if leaders at a European Union summit in Brussels agree to a credible plan to enforce budget discipline.
Such a plan is "the most important precondition for restoring the normal functioning of financial markets," Draghi said.
The ECB announced several measures intended to stimulate lending and investing and bolster Europe's financial system:
— It cut its key interest rate by a quarter percentage point to 1 percent. It was the second rate cut in only five weeks for the bank, the top monetary authority for the 17 nations that use the euro.
— It said banks could borrow unlimited amounts of ultra-cheap money for up to 36 months and that it would loosen rules on collateral for these loans by accepting lower-rated mortgages and bank loans.
— It also relaxed rules on how much capital banks must hold in reserve with the ECB. That will free up the banks to lend and invest more.
Draghi has said the eurozone economy could be heading for a mild recession. The rate cut is intended to promote economic growth and business optimism that policymakers are tackling the crisis. A slowing economy would only make it harder for European governments to pay down debt.
Analysts said the rate cut would have only a modest impact, at best. "I thought they'd be more aggressive and cut by 50 basis points because the economy looks like it's heading for recession and the banking sector is facing big pressures," said Neil MacKinnon, global macro strategist at VTB Capital.
Large-scale bond purchases, however, would help drive down government borrowing costs, which have risen to crippling levels in Italy and Spain, Europe's third- and fourth-largest economies.
By stabilizing the finances of Europe's governments, the ECB would then strengthen the continent's financial system. European commercial banks that own government bonds face potentially huge losses and, as a result, they have curtailed lending to each other, banks and consumers. That credit squeeze is felt globally.
But Draghi's comments Thursday frayed the nerves of markets. Germany's DAX stock index dropped 2 percent, while Italy's FTSE MIB index dropped 4 percent. In the U.S., the Dow Jones industrial average fell 0.9 percent, with shares of JPMorgan Chase declining 2.4 percent.
European banks stocks fell even more. Italy's Intesa Sanpaolo sank 7.2 percent, France's Societe Generale fell 6.4 percent and Germany's Deutsche Bank shed 4.3 percent.
The yield on the benchmark 10-year Italian government bond jumped a quarter of a percentage point, a large move, to 6.12 percent. The yield on Spain's 10-year bond rose one-third of a percentage point to 5.71 percent.
"Investors who had been expecting some kind of great immediate action that was going to fix things are starting to get nervous," said Fred Cannon, chief equity strategist at the investment firm Keefe, Bruyette & Woods.
Other analysts took a more sanguine view of Draghi's comments, saying he did not shut the door to further intervention but rather sought to put more pressure on EU leaders in Brussels.
"To some degree Draghi had no choice but to dampen hopes for more bond purchases, as otherwise he would have taken away pressure on the EU summit to decide on the necessary reforms of the currency union," Joerg Kraemer, the chief economist at Commerzbank, said.
On Dec. 1, Draghi urged European leaders to agree on "a fiscal compact" that would prevent eurozone governments from piling up too much debt and punish violators.
He then said: "Other elements might follow, but the sequencing matters."
Analysts say the ECB has several options to intervene more forcefully. It could:
— Explicitly tell markets that it won't permit Italian and Spanish bond yields to rise above, say, 5 percent. The central bank would then buy bonds until the yields fall to that level.
— Ramp up its purchases without an announcement and let the markets take notice.
— Issue a more vague statement that it stands ready to support governments.
— Lend to the International Monetary Fund, which could then help expand the size of Europe's bailout fund.
Draghi appeared to dismiss the possibility of ECB lending to the IMF. He noted that the ECB is not a member of the IMF and is forbidden by the EU treaty from lending to goverments. "If the IMF were to use this money exclusively to buy bonds in the euro area, we think it's not compatible with the treaty."
The ECB's main decision-making body is a 23-member governing council, chaired by Draghi. It is made up of the top central banker from each of the 17 countries that use the euro, plus a six-member executive committee that manages the bank's business at its Frankfurt headquarters.
Throughout the Great Recession, the ECB never lowered its target rate below 1 percent. By comparison, the U.S. Federal Reserve's target for short-term rates is 0-0.25 percent and the Bank of England's 0.5 percent.
The ECB raised rates twice earlier this year, in April and July, under former President Jean-Claude Trichet. It cut rates at Draghi's first policy meeting Nov. 3.
Lower rates are intended to stimulate growth by making it cheaper for businesses and consumers to borrow and spend. In the third quarter, economic growth in the eurozone was a meager 0.2 percent. Many economists believe the region's economy will shrink in the fourth quarter.
Lower interest rates can also push prices and wages higher. The fear of stoking inflation was a major reason why the ECB had been cautious about lowering rates earlier this year. But many economists say that with Europe likely headed for a mild recession, and possibly worse, the greater danger on the horizon is deflation, or falling prices and wages.
The inflation rate in Europe stands at 3.0 percent. That's above the bank's stated goal of just under 2 percent. But the bank forecasts it will fall in coming months.
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