ECB LIKELY TO EXTEND EMERGENCY BANK SUPPORT / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

ECB likely to extend emergency bank support

By Ralph Atkins in Frankfurt

Published: August 29 2010 17:08

The European Central Bank is expected this week to extend emergency support for eurozone banks until early next year as it gauges how well the 16-country region might withstand a big US or global slowdown.

Eurozone growth is exceeding the ECB’s expectations, and signs have emerged of Germany’s rapid growth spurt becoming broader than just export-led. But on top of the US economy’s weaknesses, the threat still posed by member countries worst hit by this year’s crisis over public finances is encouraging the central bank to take a distinctly cautious stance.

Jean-Claude Trichet, president, is expected on Thursday to announce that at least until the start of 2011 banks’ demands for weekly, monthly and – probably – three-month liquidity will continue to be met in full. Thus its policy of unlimited liquidity provision, which the ECB sees as its equivalent of “quantitative easing”, which was launched after the collapse of Lehman Brothers in late 2008, will be extended into a third year.

The outcome of this week’s meeting became clearer when Axel Weber, Bundesbank president, spoke recently in favour of shelving the ECB’s “exit strategy” until the start of next year. His comments in a Bloomberg Television interview irritated others on the ECB’s 22-strong governing council by pre-empting Thursday’s discussion. But they showed even “hawks” on the council were not urging early action. “If he is arguing for focusing on the first quarter, I don’t think anyone will oppose that,” said Thomas Mayer, chief economist at Deutsche Bank.

The ECB will also keep open the option of reactivating its government bond purchasing programme launched in May, although such a step would be seen as risky by several on the council. Purchases have fallen to a trickle in recent weeks. The ECB’s main interest rate will remain firmly at the record low of 1 per cent.

ECB forecasters have long expected slower growth in the second half of this year. Even if the US economy drags down eurozone prospects, however, the slowdown in Asia is not expected to be dramatic. The forecast for eurozone growth this year is likely to be increased from the range with a midpoint of 1 per cent predicted in June. But the ECB is not yet convinced the recovery has become self-sustaining. Bank lending to business continue to contract.

Moreover, overall eurozone growth data mask wide divergences, and a global slowdown would set back hopes of exports helping Greece or Portugal to kickstart their economies. Ireland, where worries have resurfaced about the cost of supporting its bank system, has strong trade links with the US. Nevertheless, Mr Weber also captured the mood on the ECB council when he told Bloomberg Television that “it’s clear we need to re-embark on a normalisation procedure”.

At Thursday’s meeting there could be discussion about reintroducing an auction system for three- month liquidity. ECB policymakers worry that the large amounts of liquidity in the financial system and low borrowing costs could sow the seeds of future crises. Lower market interest rates mean the ECB’s monetary policy stance is even more supportive of growth than in early 2009, when the post-Lehman Brothers economic slump was at its most intense.

Copyright The Financial Times Limited 2010.