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Lagarde’s hard work before the bet

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European Central Bank President Christine Lagarde is redoubling efforts to reach an agreement on a still-in-progress new bailout mechanism, people familiar with the matter said.

Two days before Thursday’s decision, policymakers still have to work to reach an agreement on a measure that could stop market speculation on weaker eurozone members.

Officials are debating the instrument, along with the question of whether to effectively waive the quarter-point rate hike advance or double it. A larger increase could be part of a compromise in negotiations on an anti-crisis mechanism.

Along with lingering legal issues, outstanding issues include conditions that countries that benefit from the ECB’s bond purchases will have to comply, the people said. These could include prudent fiscal policy, with some officials pushing to involve the European Commission, the European Stability Mechanism or both, rather than being the sole judge, they said.

An ECB spokesman declined to comment, citing a period of calm ahead of this week’s policy meeting.

Markets are betting 40% on a half-point rate hike this week but cut bets on subsequent results, estimating a 97 basis point tightening by September after an earlier one percentage point increase. The euro rose 1.2% against the dollar to $1.0269, the highest since July 6.

Lack of agreement on a so-called “Protection Mechanism” may leave Lagarde with only a far-fetched result that can be made public for now. This may lead to the prospect of a longer decision-making process to complete the development of a credible measure.

The risk of such an outcome is that it could trigger another surge in financial market speculation about the ECB’s determination to protect the integrity of the euro, which recently fell to parity with the dollar for the first time in two decades.

The lack of an announcement of an anti-crisis tool in June, combined with global turmoil due to elevated US inflation, prompted Lagarde to call an emergency meeting, where she secured a promise from her colleagues that such a tool would be created.

Bundesbank President Joachim Nagel has outlined the strict limits he sees as necessary for any agreement. He is concerned that the ECB’s single-country bond purchases could violate the central bank’s ban on government funding.

Any new instrument is likely to face legal challenges that will lead to scrutiny by Germany’s constitutional court.

Another question is how long the ECB will hold the bonds it buys. Whereas previous programs have specifically allowed the central bank to sell assets if they are no longer needed, politicians have never actively done so so far.

Governing Council Francois Villeroy de Gallo said this month that the ECB should be able to part with bonds before they mature.

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