ECB moves to ease credit markets

THE EUROPEAN Central Bank (ECB) has embarked on a €60 billion plan to buy covered bank bonds as part of a three-pronged package of steps it hopes will stem the euro zone’s economic decline and boost confidence in credit markets.

The announcement that the ECB was to adopt credit-easing measures for the first time coincided with the governing council’s decision to cut the key ECB lending rate by a further quarter-point and to double the maximum length of time over which it provides unlimited liquidity to banks.

Mr Trichet said he would give full details of the credit-easing measures at the ECB governing council’s next monetary policy meeting on June 4th.

The rate cut, which takes euro zone interest rates down to a fresh historic low of 1 per cent, reflects expectations that prices in the euro zone will continue to be “dampened” by the collapse in commodity prices and a “marked weakening of economic activity in the euro area and globally”, Mr Trichet said.

However, he added that there were “tentative signs” that the economy was stabilising “at very low levels” after a first quarter that was worse than expected.

The Bank of England, which also met yesterday, decided to keep interest rates on hold at 0.5 per cent. It also announced a £50 billion extension of its quantitative easing programme, which now amounts to a £125 billion plan to buy assets such as government bonds (gilts).

Mr Trichet denied that the ECB’s plan to buy covered bank bonds amounted to quantitative easing or “printing money”. The definition of quantitative easing varies, but is sometimes restricted to the purchase of government debt using newly created money.

However, analysts interpreted the move as the first step towards fully-fledged quantitative easing. The ECB’s announcement also marks a setback for governing council members, including the head of the German Bundesbank Alex Weber, who had argued that debt purchases should not take priority over other measures to tackle the economic crisis.

The ECB joins the Federal Reserve, the Bank of Japan and the Bank of England in buying bonds to spur growth, but its plan is on a smaller scale.

“The amount committed, around €60 billion, is quite small, and the plan is rather vague at this point,” said David Woo, global head of currency strategy in London at Barclays, while AIB’s global treasury economic research team wrote in a note that the plan was “relatively modest” given the size of the euro zone economy.

The ECB plan is equivalent to about 0.5 per cent of euro region GDP. That compares to debt purchase programmes in the UK and the US amounting to 8 per cent and 2 per cent of GDP respectively, according to analysts from the Lloyds TSB Group.

The ECB also said yesterday that the European Investment Bank (EIB) will also be allowed to gain access to ECB funding by taking part in the central bank’s money market operations.

The ECB kept its overnight deposit rate, which is acting as a floor for money markets, at 0.25 per cent, narrowing the gap between its policy rates instead of cutting the lowest of these to zero.

The ECB also cut its marginal lending rate by 50 basis points to 1.75 per cent, from 2.25 per cent – keeping the rate corridor symmetrical. The new rates will take effect on May 13th. Money market rates have hit record lows in recent weeks in response to the ECB’s generous liquidity provision and interest rate cuts but lending growth to firms and households is still slowing.