European central banks to blast cash into economy

[February 08, 2012]  FRANKFURT, Germany (AP) -- With Europe sliding toward recession, the region's two main central banks are preparing to redouble their emergency measures aimed at softening the downturn and blunting the effects of the government debt crisis.

Analysts expect the U.K.'s central bank, the Bank of England, to announce Thursday that it will inject another 50 billion pounds ($79 billion) of new money into an economy that shrank at the end of last year.

Meeting the same day at its headquarters in Frankfurt, Germany, the European Central Bank is expected to trumpet the advantages of its second unlimited offering of cheap, three-year loans to be allotted to banks on Feb. 29.

Neither central bank is expected to change interest rates from their current record lows -- the Bank of England at 0.5 percent and the ECB at 1.0 percent. Rather, attention will focus on their outlooks and their attempts to push more money into the banking systems and the economy.

A first blast of cheap ECB credit -- euro489 billion ($641.23 billion)- was taken up by 523 banks on Dec. 23. The step has been credited with calming some of the market panic from the debt crisis hitting the 17 countries that use the euro, and stocks and government bonds have risen since then. Analysts think the takeup could equal or exceed the first one, since the ECB has loosened collateral requirements.

Despite a remarkable easing in tensions on financial markets this year -- particularly evident in the big drop in the borrowing rates of weak countries like Italy and Spain -- the 17-country eurozone and the U.K. face worrying signs from the wider economy.

The eurozone economy is widely expected to have contracted in the fourth quarter, while the U.K. shrank 0.2 percent in the last three months of the year. Many analysts predict both regions will fall into a technical recession -- defined as two consecutive quarters of negative growth -- by the end of March.

Both remain exposed to any sudden shock from the crisis in Europe over too much government debt -- financial volatility quickly causes credit to seize up, stifling economic activity.

A messy default by Greece -- currently in drawn-out talks with other eurozone governments, the ECB and the International Monetary Fund about a second bailout -- would threaten the integrity of the eurozone, shaking British and world markets as well.

Recent economic indicators for Britain and the eurozone have suggested things may pick up a bit in the months ahead, but big risks remain.

Credit availability, crucial to help businesses expand and create jobs, appears to be dropping in the eurozone. An ECB survey of banks indicated that the number tightening lending requirements surged at the end of last year, to a net 35 percent from 16 percent.

Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club, says Britain still needs a further shot of stimulus thanks to the commotion across the Channel.

"Short-term prospects remain on a knife-edge given the ongoing policy paralysis in the eurozone. If the crisis deepens, it would most likely reverse all of the pickup seen in the last couple of months," he said.

Analysts think the Bank of England will create new money to buy securities -- mostly British government bonds -- from private investors such as insurance companies and pension funds, on top of 275 billion pounds ($437 billion) it has already purchased.

The hope is that the purchases, known as quantitative easing or QE, will increase the amount of cash flowing through the financial system, which will in turn help lower interest rates and borrowing costs for businesses and raise asset prices. Quantitative easing can be inflationary, but analysts say the bank has room to act as inflation is widely forecast to fall from 4.2 percent toward the official 2 percent target over the next two years.

Vicky Redwood, chief U.K. economist at Capital Economics, said inflation "is expected to fall some way short of target."

"Accordingly, we think the big picture will be that further QE is still needed," Redwood added.

The U.S. Federal Reserve, which has already done two rounds of quantitative easing, has raised the possibility of doing another round as well.

For its part, the ECB may remain in a holding pattern on interest rates for some time, barring a sudden financial disaster in Greece. The country's political leaders need to agree to tough austerity terms this week if Athens is to get more bailout loans in time to pay debts coming due March 20 and avoid default.

ECB president Mario Draghi is likely to face questions over whether the central bank will help find more money for the Greek bailout, now believed to be euro15 billion short of Greece's needs.

Eurozone officials have suggested that the bank find a way to donate potential profits it may make on euro55 billion ($72 billion) in Greek bonds it bought for around euro40 billion on the secondary market. It could do that by selling the bonds to the eurozone bailout fund for what it paid for them, and the fund could then write them down.

Some analysts say the ECB isn't in principle opposed to such a move, but is holding back to not appear to be taking instructions from governments -- it is forbidden by the EU treaty to do that. Draghi turned aside questions about the issue at the bank's January meeting but will be pressed for a clearer statement this week.

[Associated Press; By DAVID McHUGH]

Robert Barr and Pan Pylas in London contributed to this report.

Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.