ECB to hold fire on rates, loans as crisis eases

[March 08, 2012]  FRANKFURT, Germany (AP) -- The European Central Bank will likely keep its interest rates and emergency credit programs on hold on Thursday, as it monitors the positive impact that its massive loans to banks have had on financial markets.

The ECB is credited with pulling Europe back from the debt crisis brink by offering a total of euro1 trillion ($1.32 trillion) to banks on Dec. 21 and Feb. 29. That eased a looming credit crunch, supported investor confidence, and caused borrowing rates to ease for financially weak countries like Italy and Spain.

With markets now more stable and inflation still higher than the bank likes to see, most analysts expect the 23-member governing council to decide to leave interest rates at 1 percent -- probably for several months -- and hold off more loans.

President Mario Draghi, however, will likely face questioning at his post-decision news conference about warnings from Germany's Bundesbank, about the risk the ECB has taken on by loosening rules for collateral on the emergency loans.

The Bundesbank, which holds one seat on the ECB council, apparently voted in favor of the latest bank loans. But it has expressed concern that excess liquidity can lead banks to buy risky assets and that the crisis cannot be solved "solely by throwing money at it," as Bundesbank head Jens Weidmann said in a speech.

Weidmann reportedly wrote Draghi a letter expressing concern about the risk of the looser collateral standards. The text of the letter has not been made public.

Whatever the longer-term risks, few deny the bank loans have eased the debt crisis by at least buying governments time to clean up their finances.

After the first issue of emergency loans in December, it became clear that some banks were using the money to buy government bonds, lowering bond interest rates and borrowing costs for hard-pressed governments. That indirect support was crucial because it is high borrowing costs that pushed Greece, Ireland and Portugal to seek international bailout loans.

Additionally, the high number of banks taking up the second offer -- 800 banks took euro530 billion in the latest offering -- suggests that more small banks took their turn loading up on cheap, long-term financing. The loans are for up to 3 years and right now cost only 1 percent annual interest.

With risks of bank failures due to the debt crisis effectively removed by that step, attention is turning to whether the money will ever make it to companies and consumers in the form of loans that could help the economy grow.

It could be months before that's apparent, giving the ECB a reason to stand pat, says Marco Valli, chief eurozone economist at UniCredit. So the bank may stand back and watch how things develop.

"The probability of a further reduction in the policy rate has decreased appreciably over the last couple of months," Valli said. "We see good chances that the ECB has eventually entered a prolonged period of wait-and-see posture, both on conventional and unconventional policy."

Inflation has lingered above the ECB's goal of just under 2 percent, running at 2.7 percent in February. The higher rate is mostly attributed to volatile, higher oil prices, and is expected to fall under 2 percent next year.

But possible upward pressure on prices -- not a worry amid gloomy forecasts and slack demand two months ago -- is starting to come back into focus, especially in Germany where unemployment remains low. German labor unions are demanding 6.5 percent wage increases as national negotiations begin, and real estate prices have risen, especially in bigger cities.

Analysts at RBS, who originally predicted a quarter-point rate cut, now say rates will remain unchanged. But they still foresee quarter-point cuts in June and September, based on a more pessimistic view of the economy.

The eurozone economy shrank 0.3 percent in the fourth quarter and the European Union's executive commission predicts it will shrink another 0.3 percent in 2012.

The Bank of England will also hold its monthly meeting on Thursday, but its Monetary Policy Committee is not expected to move its key interest rate from a record low of 0.5 percent or vote for further monetary stimulus.

Recent economic indicators have been somewhat better than expected, so analysts expect the next stimulus package will not be cleared before May. In the meantime, the Bank of England will be monitoring external developments such as the debt crisis brewing in nearby European countries, the strength of the economic recovery in the U.S. and the rise in oil prices, which is keeping inflation above target.

[Associated Press; By DAVID McHUGH]

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