ECB to monitor impact of 'hectic' volatility

The impact of "hectic" market volatility will have to be closely watched, European Central Bank (ECB) president Jean-Claude Trichet said yesterday, after weak Japanese and US data pointed to a global credit crisis inflicting wider economic damage.

"We will certainly remain alert at a global level. It is no time for complacency," Mr Trichet told a news conference after chairing a gathering of central bankers from G10 nations.

"We will have to follow very carefully what happens in particular in the United States," he said. "The Fed has said that there was probability of fallout on the real economy in the US."

Japan's economy shrank more than expected in the second quarter, official figures showed yesterday. Economists had expected a weak number, but the 0.3 per cent fall was bigger than forecasts for a 0.2 per cent contraction.

That followed data on Friday showing US payrolls shrank in August for the first time in four years, suggesting that the credit squeeze was beginning to stifle growth there.

The twin reports hardened prospects that the Bank of Japan will hold interest rates steady and the Federal Reserve will cut them to temper the worst effects of the crisis, stemming from defaults on US subprime mortgages granted mainly to poor people.

The US home loan trauma has prompted banks to choke off lending to each other as they strive to calculate exposure to the sector, forcing the world's central banks to pump emergency funds into the financial system to prevent it seizing up.

Until the crisis blew up, the ECB, Bank of Japan and Bank of England had all been expected to raise rates, while the Fed was seen on indefinite hold.

Investors now see a US rate cut, at or before the Fed's September 18th meeting, as inevitable, with speculation switching to whether it will be a quarter or half-point reduction.

Maybe only the latter can now ease market gyrations.

"A rate cut by the US Federal Reserve would certainly ease investor concerns and it is increasingly likely that it will happen. But short of that, it is hard to see what the catalyst will be for investors' nerves to be soothed," said Martin Arnold, an equities economist at CommSec in Sydney.

The next few weeks will be a critical period in the credit crunch saga and not just because of the Fed's looming meeting.

Attempts to refinance over $113 billion (€82 billion) of short-term commercial paper this week will be an important gauge of the depth of this crisis.

And a key imponderable - how much banks will be forced to write off and whether some will be forced to issue profit warnings - will be answered during the upcoming third-quarter results season.

Société Générale, France's second-biggest listed bank, said yesterday its financial targets for 2007-2008 were unchanged, despite experiencing difficult market conditions in August. - ( Reuters )