ECB report warns bond writedowns could damage euro

By Marc Jones

FRANKFURT (Reuters) - The European Central Bank reiterated a broad warning on Thursday that any form of government debt writedown that forces the private sector to take losses could damage the euro and the bloc's banks.

In a sub-section of one of the articles in its monthly bulletin, the bank said it remained opposed to any form of non-voluntary or compulsory writedown, pointing back to comments by its President Jean-Claude Trichet in June.

Those concerns did not prevent the ECB from going along with a set of measures agreed in July to combat the debt crisis, which included a mechanism allowing for a 21 percent write-off of private sector holdings of Greek debt.

The ECB's warning on Wednesday was directed rather at the broader concept of forcing investors to take losses on euro zone bonds and made no specific reference to the current debate on increasing the 21 percent figure for Greek bondholders.

"Private sector involvement (forcing writedowns) could damage the reputation of the single currency internationally, possibly adding to volatility in foreign exchange markets," the box in the monthly report said.

"In particular, public and private international investors may be cautious about investing large portions of their wealth in assets denominated in a currency of sovereigns that may not fully honor their obligations."

The monthly report, and the research included in it, give a clear insight into the central bank's thinking. Research on topical issues typically support the bank's view and the messages its policymakers are sending behind the scenes.

The warning of the impact on the euro was enough to knock back the single currency, which has gained this week on hopes policymakers were moving toward a comprehensive solution to the crisis.

Before July's move, a number of top ECB members warned forcing losses could lead to turmoil to rival that following the 2008 collapse of U.S. investment bank Lehman Brothers.

Senior ECB policymakers, including Trichet, have also underlined that governments also indicated at the time that Greece's situation was a one-off.

The monthly bulletin underscored the ECB's concerns about the impact writedowns will have on banks.

"Private sector involvement can be expected to have direct negative effects on the banking sector across the euro area," it said. "This could trigger a need for large-scale bank recapitalization."

Over the last few weeks euro zone governments have began to focus their attention squarely on shoring up the region's banks to protect them from the fallout of the debt crisis.

Following France and Belgium's rescue of Dexia earlier this week, Europe's banks expect to be told to raise more capital, either by tapping markets or using government backstops.

(Reporting by Marc Jones)