Banks to be focus of unconventional ECB response to crisis, says Trichet

BANKS WILL be the focus of any unconventional European Central Bank policy response to the financial crisis, ECB president Jean-Claude Trichet said yesterday, adding the ECB needed a strategy to reverse the measures.

Mr Trichet, who is due to unveil plans for further unconventional policy steps next month, gave no details of the plans, saying he did not want to create expectations. In the US, Britain and Japan, central bank responses have involved purchases of bank and government debt.

Mr Trichet also said he appreciated US policymakers saying a strong dollar was in US interests, adding that it was not realistic to say the euro is weak now as the single European currency was stronger than at its launch a decade ago.

He offered little insight into what the ECB would do, but said it would keep in mind the dominant role that banks played in ensuring access to credit. The euro fell to its lowest in a month against the dollar after Mr Trichet’s comments.

“Though Mr Trichet’s comments today provided few surprises, he also seemed to suggest that he does not want to cut rates further after May,” said Takahide Nagasaki of Daiwa Securities SMBC. “Such a stance may not work in the euro’s favour as it casts doubts on the euro zone’s economic recovery prospects.”

Mr Trichet said at this stage, he thought it was “important not to create or encourage expectations. Be sure that what we will decide will fully take into account the financing structure of the euro area economy and will be fully in line with our medium-term strategy,” he said.

The ECB has so far resisted buying assets as a way to pump money into the economy, unlike the US Federal Reserve, the Bank of England and the Bank of Japan, but it plans to announce “non-standard” measures at its next policy meeting on May 7th.

ECB executive board member Lorenzo Bini Smaghi, also speaking yesterday, stressed the importance of the banking channel in a speech in Berlin.

“If you want to fix the transmission of monetary policy, in the euro area you have to work mainly with banks,” he said.

Mr Trichet also said the ECB must balance the need for action with the need for a plan on how to exit such policies in future.

“Confidence today relies equally upon the audacity of our immediate decisions and upon the soundness and credibility of our exit strategies,” Mr Trichet said.

The ECB has cut its benchmark rate by 3 percentage points since October and is expected to cut its headline rate by another 25 basis points to 1.0 per cent in May as the euro zone struggles with its worst recession since the currency was created.

With the global economy in its worst downturn in recent history, inflation is slowing, but some investors are worried that huge cash injections by the world’s central banks could spark inflation.

Despite the downward economic spiral, the ECB has repeatedly ruled out cutting rates to zero and has kept rates noticeably higher than many of its peers, including the US Federal Reserve, the Bank of Japan and the Bank of England. It is likely the ECB will, at the May meeting, extend from six months the maximum period for which it will supply unlimited liquidity to euro zone banks.

But analysts warned the ECB risked a damaging backlash if other steps were not unveiled on May 7th. Markets would conclude either that the ECB saw no need for extra measures or could not agree on how to proceed, argued Marco Annunziata, chief economist at Unicredit.

Also yesterday, US Federal Reserve chairman Ben Bernanke conceded that the collapse of US lending would probably cause “long lasting” damage to home prices, household wealth and borrowers’ credit scores. “One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be,” Mr Bernanke said, addressing the central bank’s community affairs conference in Washington.

“The damage from this turn in the credit cycle – in terms of lost wealth, lost homes, and blemished credit histories – is likely to be long lasting.” – (Reuters / Bloomberg)