Thursday, June 4, 2009

ECB Keeps Key Rate at Record-Low 1% as Signs of Recovery Emerge

By Christian Vits

June 4 (Bloomberg) -- The European Central Bank kept its benchmark interest rate at a record low of 1 percent today after first signs of an economic recovery emerged.

The Frankfurt-based ECB will also reveal details of its asset-purchase plan, and economists say it is unlikely to signal it will buy more than the 60 billion euros ($85 billion) of covered bonds already announced. President Jean-Claude Trichet, who is trying to heal a rift among policy makers, holds a press conference at 2:30 p.m.

“The reality is that the ECB are done cutting rates and will not be announcing any further policy initiatives,” said James Nixon, an economist at Societe Generale SA in London. Still, “I’m very concerned that much more has to be done to stimulate the economy from here.”

The 22-member Governing Council has been split over whether to follow the Federal Reserve and Bank of England, which have cut their key rates close to zero and are buying government and corporate bonds to tackle the worst recession in six decades. The debate over how far the ECB should go reached the highest level of European government this week, with German Chancellor Angela Merkel backing the Bundesbank’s view that asset purchases are a step too far.

Clash of Views

Bundesbank President Axel Weber argues there is no real risk of deflation and buying assets to flood the economy with money is an unnecessary risk that could sow the seeds of future crises. Officials from smaller nations such as Slovenia’s Marko Kranjec and Cyprus’s Athanasios Orphanides are less certain and have indicated the ECB could buy a broader range of assets to fight the recession.

The Bank of England today kept its key rate at 0.5 percent and reiterated its plan to buy 125 billion pounds ($206 billion) of government and corporate bonds.

Investors will be looking for information from Trichet on the types of covered bonds the ECB will purchase, whether they will be bought on the primary or secondary markets, and whether national central banks will conduct the operations.

The ECB’s plan is worth 0.6 percent of euro-region gross domestic product. By contrast, the asset-purchase programs of the Fed and Bank of England amount to about 12 percent and 10 percent of their respective economies.

Green Shoots

ECB purchases are “no more than a gesture,” said Thomas Mayer, chief European economist at Deutsche Bank AG in London. “The economy is on its way to stabilizing and I would expect growth to turn positive later this year.”

Evidence is mounting that the worst of the financial crisis may have passed. The contraction in Europe’s manufacturing and service industries is easing and European confidence in the economic outlook rose to a six-month high in April. In Germany, Europe’s largest economy, business sentiment increased for a second month in May.

Praktiker AG, Germany’s second-biggest home-improvement retailer, said on May 27 that revenue has rebounded in its domestic market since the end of March.

Merkel on June 2 scolded the Fed and Bank of England for pumping too much money into their economies and said that by deciding to buy covered bonds, the ECB had “bowed somewhat to international pressure.” She urged a return to a “policy of reason.”

Original Package

At its May 7 meeting, the ECB debated a package of asset purchases worth about 125 billion euros that included commercial paper and corporate bonds, before agreeing to buy only covered bonds, people briefed on the talks have said. Covered bonds are low-risk securities backed by mortgages or public-sector loans.

Weber may have been instrumental in having the package reduced. He said on May 12: “Note well: It’s not our goal simply to print money. I currently don’t see the need for outright purchases of further private debt obligations.”

Others want to keep that option open. Kranjec said in a May 13 interview that the ECB hadn’t ruled out purchasing a wider range of assets and was “very likely” to spend more than 60 billion euros.

Austria’s Ewald Nowotny, in a May 29 letter to hoteliers obtained by Bloomberg, said the ECB can buy commercial paper and bonds to help lower long-term interest rates.

The euro-region economy will shrink 4.2 percent this year, according to the International Monetary Fund. That’s more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K. Trichet said last month that the ECB’s latest staff projections, due today, are likely to be in line with those of the IMF.

The ECB will keep the door “wide open” for additional policy action, said Holger Schmieding, chief European economist at Bank of America-Merrill Lynch in London. “Apparently there’s no consensus in the Governing Council, so there’s a chance the ECB will come up with a surprise.”

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