ECB opens cash taps to avoid new credit crunch

October 6, 2011 - 12:50 PM
Germany Europe  Financial Crisis

Outgoing European Central Bank President Jean-Claude Trichet gestures during his last news conference as president after a governing council meeting of the European Central Bank hosted by the German Federal Bank in Berlin, Thursday, Oct. 6, 2011. (AP Photo/Markus Schreiber)

BERLIN (AP) — The European Central Bank is opening its money taps wide to prop up an increasingly shaky banking sector and keep the region's debt crisis from spawning the type of credit crunch that plunged the global economy into recession two years ago.

In the move announced Thursday, the top monetary authority for the 17 euro nations offered to flood banks with any amount of one-year loans through 2013. The hope is that will shield them from malfunctioning credit markets, in which banks are becoming too worried to lend to each other, and keep loans flowing to businesses and households.

But outgoing ECB President Jean-Claude Trichet resisted calls for an interest rate cut to spur growth despite fears that the eurozone economy is sinking toward a renewed recession. The bank's main mandate is fighting inflation, which can be worsened by rate cuts.

The ECB's caution over inflation contrasted with a move by the Bank of England, which reopened a securities purchase program that essentially prints new money to boost Britain's stagnant economy — despite an inflation rate of 4.5 percent.

Trichet, holding his last news conference before retiring at month's end, did not even indicate that a rate cut was possible at the next month's meeting, as many economists expected because of signs the eurozone economy is grinding to a halt.

"The economic outlook remains subject to particularly high uncertainty and intensified downside risks," Trichet said, adding however that "interest rates remain low" and inflation will likely remain well above target for months.

Analysts said that a rate cut was probably postponed, not canceled, and that Trichet may simply have been leaving successor Mario Draghi maximum room to maneuver.

"Falling leading indicators suggest that the ECB will lower its expectations for economic activity considerably," said economist Joerg Kraemer at Commerzbank. "The ECB will presumably cut its key rate towards year-end and again next spring."

That would bring the benchmark refinance rate to 1.0 percent from its current 1.5 percent.

Instead of cutting rates, Trichet focused on emergency credit measures to keep the financial system working properly.

Many European banks are exposed to losses on government debt from Greece and other countries with shaky finances. That has made borrowing between banks, crucial for their daily functioning, increasingly difficult because of fears the money might not be repaid.

Those jitters have intensified in recent weeks and threaten to claim their first victim since the 2007-2009 financial crisis, Franco-Belgian bank Dexia. Dexia was already bailed out in the earlier phase of the crisis and now is struggling again to raise funding.

To help, the ECB will offer an unlimited amount of 12-month and 13-month loans to banks. That will provide them financing for a longer period — into 2013 in the case of the 13-month offering — and shield them from turbulence in borrowing markets.

The ECB will also keep offering unlimited amounts of shorter-term loans, with maturities of up to 3 months, through the first half of next year and buy up to euro40 billion ($53 billion) in covered bonds, a type of security used by banks to raise funding.

Trichet said that the 23-member rate-setting council made its interest rate decision by consensus, not by unanimity, suggesting there were voices calling for a cut — voices that might gain the majority in coming weeks if signs of a downturn increase.

The eurozone economy grew only 0.2 percent in the second quarter. Business and consumer optimism is suffering due to the financial market turmoil over fears that some governments have too much debt and might not pay it all back.

Trichet, who will be succeed by Bank of Italy head Draghi at the end of the month, leaves office with his typical stance — as a strict inflation fighter. Under his tenure the ECB resisted widespread calls to lower rates in 2004 and to not increase them in 2005, calls it ignored.

Lower rates can mean a short-term boost to growth and jobs. But rates that are too low can cause inflation over the longer term and undermine the value of the currency.

The ECB's main role under the EU treaty is defending against inflation, which unexpectedly spiked to 3.0 percent in the eurozone in September from 2.5 percent the month before. The ECB expects inflation to fall below 2 percent by next year.

It was that role that Trichet focused on as he reminisced briefly about his eight years in office, pointing to both the bank's record at keeping inflation close to its goal of just under 2 percent over the nearly 13 years of its existence, and at keeping inflation expectations in line with that.

"Have we delivered price stability? Yes, we have delivered price stability," he said. "Are we credible in delivering price stability over the next 10 years? Yes. These are not words, these are deeds."

"On top of that we have to cope with the worst crisis since World War II," he said.