Europe's top central banker said on Thursday that euro zone governments are on the right track to restore market confidence but reminded them that an emergency program to buy their bonds was neither eternal nor infinite.
Mario Draghi's comments came after a smooth Spanish bond auction eased fears of an accelerating slide in European markets following a summit last week that failed to reassure investors the single currency area is closer to resolving its debt crisis.
The European Central Bank chief said in a speech in Berlin that the 17 euro zone governments are now on the right track and they are right in implementing budgetary consolidation resolutely.
The unavoidable short-term (economic) contraction may be mitigated by the return of confidence, he said.
To mitigate risk aversion rife in markets, Draghi said more policy clarity was necessary, and he urged politicians to speak unambiguously, then deliver.
Spanish bond yields fell, narrowing the spread over German Bunds, after the country surprised markets by selling far more than the amount targeted in its last bond sale of the year, although come of its costs of borrowing remained close to euro-era highs.
The euro rose for a while above $1.30 after touching an 11-month low of $1.2945 on Wednesday, and European shares gained more than three-quarters of a percent partly due to relief over the Spanish auction.
With many financial institutions closing their books for the year, the next major market test for the euro zone is widely expected in mid-January, when Italy has to start rolling over more than 100 billion euros of expiring debt by April.
To try to restore market confidence in the euro zone's third largest economy, Rome's new technocratic government has called a confidence vote in parliament on Friday to speed up approval of a 33-billion euro ($43 billion)austerity package.
Prime Minister Mario Monti has raced to push through a law that cuts spending and raises taxes to shore up public finances and cut a debt running at 120 percent of gross domestic product. The government resorted to a confidence vote to curb debate on dozens of amendments, many tabled by the opposition Northern League.
European Union leaders will hold another summit in Brussels in late January or early February to discuss economic growth and jobs as the 27-nation bloc heads into a quasi-recession, European Council President Herman Van Rompuy said on Thursday.
Germany and France called on Wednesday for an extra meeting to discuss growth at a time when the euro zone looks likely to enter recession in the last quarter of this year. EU leaders last met on December 8-9, when they agreed to forge a new pact for stricter enforcement of debt and deficit rules in the euro zone.
In times of stagnation, in times of even quasi-recession, it is very important to have those topics on the agenda and not only speaking on fiscal consolidation, Van Rompuy said.
There are growing concerns that policymakers' focus on cutting spending to rapidly reduce deficits is making it harder to stimulate growth and create jobs, especially for the young.
Critics say the harsh austerity budgets being implemented across southern Europe will plunge those countries deeper into recession, fuelling a vicious cycle of economic contraction and falling revenues, and risking severe social unrest.
Greece, crushed under a debt mountain equivalent to 160 percent of annual output, is the most striking illustration. Its economy is now expected to contract by 6 percent this year and its budget deficit will top 10 percent of GDP despite draconian spending cuts.
The International Monetary Fund's chief negotiator with Athens, Poul Thomsen, urged the Greek government on Wednesday to rethink taboos and start laying off state workers because it could no longer rely on more tax increases and across-the-board spending cuts.
Draghi said that in the medium term, sustainable growth can be achieved only by undertaking deep structural reforms that have been procrastinated for too long.
Speaking to the economically conservative Ludwig Erhard Foundation in Berlin under a banner bearing the quotation Inflation is an expropriation without compensation for the benefit of the public purse, the Italian ECB chief was given a warm reception by the guardians of German monetary orthodoxy.
Asked how many more government bonds he would buy before a planned new treaty on fiscal union was ratified, Draghi replied: We have an SMP (securities market program) in place and as I've said several times it is neither eternal nor infinite.
He quickly moved on to the next subject, eliciting laughter.
(Additional reporting by Brian Rohan in Berlin, Kirsten Donovan in London, Ingrid Melander and George Georgiopoulos in Athens; Writing by Paul Taylor)