Jun 7, 2012 7:00 AM GMT+0800 The European Central Bank may be running out of options it canstomach. With the euro area assailed by spreading recession,financial-market instability and political impasse over thedirection the single currency should take, ECB President MarioDraghi yesterday stressed the limitations of his current policytools, from standard interest-rate cuts to bond-buying andliquidity injections. Moves such as quantitative easing or cappingbond yields to calm markets remain taboo for the ECB, which saysits main job is to ensure stable prices. It s clear that they are very low on, if not completely out of,ammunition, said Nick Kounis, head of macro research at ABN Amroin Amsterdam. There are options that would have a moresignificant effect, but they re outside of the ECB s comfortzone. |
There s an element of helplessness. Having already cut its benchmark rate to a record low of 1 percent,injected more than 1 trillion euros ($1.2 trillion) of three-yearloans into the banking system and bought 212 billion euros ofgovernment bonds, the ECB is reluctant to do more heavy lifting asgovernments procrastinate over the reforms it deems necessary toput the monetary union on a sustainable footing. Draghi questionedthe effectiveness of cutting rates further and flooding financialmarket with even more liquidity. Ready to Act Draghi said the ECB stands ready to act should the debt crisisdamp the euro-area economy further, and that a few GoverningCouncil members pushed for a rate reduction at yesterday s policymeeting. Still, we have to be aware that the context is one where you haveliquidity constraints and tensions in financial markets, he saidafter keeping rates on hold.
Price signals in this situation havea relatively limited immediate effect. Draghi also cast doubt on the impact of further longer termrefinancing operations, or LTROs, saying the full effects ofprevious loans have yet to be felt. Some of the problems in theeuro area have nothing to do with monetary policy, he said. Whether they cut interest rates or not, it won t have much of animpact, said Uwe Angenendt, chief economist at BHF Bank AG inFrankfurt. On the liquidity front, the banking sector is alreadyoversupplied.
The ball is in the court of political players. It snot for the ECB to fill this vacuum. Investor concern about political inaction drove Europe s Stoxx 600Index (SXXP) down about 7 percent last month, fully erasing gainsthis year, while the euro has plunged to a two-year low against thedollar. At least eight of the 17 euro nations are in recession. Zero Bound The ECB may be reluctant to cut its benchmark rate much furtherbecause it poses the question of whether to lower the deposit ratefrom 0.25 percent.
That has served as a floor for market interestrates since the ECB began providing banks with unlimited liquidityin 2008. Taking the rate toward zero would reduce the incentive for banks tolend to each other because the return may not compensate the risk.That in turn could freeze money markets, the very phenomenon theECB is trying to avoid with its full- allotment policy. Cutting the benchmark rate to a new record low would also put thespotlight on the ECB s other policy tools and take pressure offgovernments to implement reforms, said Ken Wattret, chief euro-areaeconomist at BNP Paribas in London. The ECB fears that the minute it cuts rates below 1 percent itwill come under huge pressure to introduce more unconventionalmeasures, such as more bond buys and more LTROs, Wattret said. I have sympathy as to why they don t want to do that, becausethe ECB has really expanded its balance sheet with limited returns.There is definitely a moral-hazard issue there.
Spanish Banks Concern over Spain s ability to recapitalize its banks has drivenup borrowing costs for the government, which is pushing for Europeto channel funds directly to its lenders. Budget Minister CristobalMontoro used a radio interview on June 5 to call for outsidesupport, saying the sums needed to aid Spain s banks aren t astronomical. Draghi repeated the ECB s call for euro-area governments to clarify their vision for the euro area while denying he srefraining from acting until they deliver. These are high-level decisions that concern the future of theEuropean integration and the future of the euro area, he said.
There s no sort of horse trading here. Do Something Draghi has joined European Union President Herman Van Rompuy,Luxembourg s Jean-Claude Juncker, who leads the group of euro-areafinance ministers, and European Commission President Jose Barrosoin drafting a program for deeper integration in the euro area. VanRompuy said on June 4 that he will report on proposed buildingblocks at the next summit of EU leaders on June 28-29 inBrussels. In the meantime, markets are clamoring for immediate action fromthe central bank, which said yesterday that risks to the economicoutlook have increased.
Draghi should start by cutting rates to lower the costs of theLTRO and primarily to show the market that the ECB is there,willing to do something, said Marchel Alexandrovich, seniorEuropean economist at Jefferies International Ltd in London. TheECB dragging its heels is not a costless exercise.
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