February 26, 2021

News Analysis: Will a Powerful Bank Act the Part?

FRANKFURT — The European Central Bank still has plenty of ammunition left in its monetary policy bandoleers. The question is whether it will use it.

The bank provided a clue Thursday when it said it would join with the United States Federal Reserve and three other major central banks in ensuring that hard-pressed European banks have a steady supply of dollar credit.

It was a more cooperative hands-across-the-water attitude than Europe’s main finance ministers displayed on Friday, when they reacted coolly to a bailout policy suggested by the Treasury secretary, Timothy F. Geithner. (American money speaks louder these days than American advice, evidently.)

The bank by agreeing Thursday to let euro zone banks borrow as many dollars as they want, indicated its willingness to deploy “nonstandard measures,” as the bank president, Jean-Claude Trichet, likes to call them.

The deeper issue is how far the bank will be willing to depart from precedent as it tries to hold the euro together. The departure would require the central bank to act much less cautiously than it has so far during the long-running euro debt crisis.

“The E.C.B. can stop this crisis in a minute if they want to,” said Guntram B. Wolff, deputy director of Bruegel, a research organization in Brussels. The bank, he said, could simply overwhelm bond markets by buying huge quantities of debt from Greece, which is effectively insolvent, as well as other countries that have come under attack, like Italy. End of crisis.

Some economists have argued that the bank could buy more than $1 trillion in sovereign debt if it needed to.

But such an action would provoke howls from Germany and countries like Finland, where the bank is seen as having gone rogue because of its relatively modest purchases of debt from a list of countries that also includes Spain, Portugal and Ireland. In those beleaguered countries, meanwhile, the bank is regarded as insufficiently supportive.

The bank is “in a very awkward position of trying to please everybody, which is impossible,” Mr. Wolff said.

Even though Europe’s sovereign debt crisis has mushroomed into a perceived threat to the world economy, the bank has so far been much more conservative than its peers. Worried about the prospect of inflation, the bank has raised interest rates this year, while the Fed and the Bank of England have kept theirs at rock-bottom levels.

The bank also stood on the sidelines while its counterparts in the United States and England flooded their economies with cash by way of so-called quantitative easing.

And the bank’s purchases of sovereign bonds for 143 billion euros, or $197 billion, so far, as part of a program to keep the recipient governments’ borrowing costs under control, is less than asset purchases by the Bank of England — which represents one country while the euro zone has more than 20 nations.

Right or wrong, the restrained policy means that the bank still has considerable firepower in reserve.

“If there is a risk of severe economic fallout, you could see the E.C.B. do more,” said Nick Matthews, an economist at the Royal Bank of Scotland. “There are more options it has not used up.”

The most obvious is the classic central bank tool: manipulating interest rates. The bank has raised its benchmark rate twice this year, bringing it to 1.5 percent from 1 percent. The increases were widely criticized as treating the wrong symptom — incipient inflation rather than depressed growth — especially after euro zone growth promptly slowed almost to nothing.

Some economists are now forecasting that the bank will reverse course on interest rates before the end of the year. And some think that Mr. Trichet may deliver a cut in October, his last month on the job before he retires.

The reasoning is that Mr. Trichet will want to make life easier for his successor, Mario Draghi, currently the governor of the Bank of Italy. Mr. Draghi might have trouble overseeing a rate cut soon after taking office in November because he will be eager to establish his credentials as a hard-liner on inflation.

But apart from interest rates, the bank has other tools it can use, Mr. Matthews pointed out in a recent research note:

¶ To help banks raise money to lend to consumers and businesses, it could resume purchases of commercial banks’ so-called covered bonds, which are generally considered low risk because they are backed by packages of loans as well as the guarantee of the issuing bank. That measure, already used by the bank in 2009, would make sense if banks in France or other countries ran into trouble selling bonds because of worries about creditworthiness.

Article source: http://www.nytimes.com/2011/09/17/business/global/will-the-ecb-use-its-firepower.html?partner=rss&emc=rss

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