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ECB weighs new credit infusion to hold down rates

October 1, 2013

FRANKFURT, Germany (AP) — European Central Bank head Mario Draghi has said the bank could unleash another flood of cheap credit if the recovery needs support. Markets are waiting for clues from Wednesday’s ECB meeting about whether it will act — or hold off and let the mere possibility continue to calm markets.

The bank is widely forecast to leave its benchmark interest rate unchanged at the record low of 0.5 percent at a meeting of its governing council in Paris.

Instead, the possibility of another offer of cheap, long-term loans to banks, perhaps later this year or early next year, has been the focus of scrutiny by economists. Expectations rose after ECB President Mario Draghi said last week the ECB could make another so-called longer-term refinancing operation, or LTRO, “if needed.”

The ECB has already done two such LTRO credit offerings, in December 2011 and March 2012, worth just over 1 trillion euros in three-year loans. The move helped banks steady their finances and weather the eurozone’s financial crisis. It removed fears that a bank might fail and bring down the government finances of a country in the currency bloc. With the worst of the crisis past, some banks are repaying the money early.

But the ECB is now considering making another LTRO because of fears the cost of credit in the open market could rise — even though the ECB has kept its benchmark interest rate at the record low. Some market rates rose due to expectations that the U.S. Federal Reserve would tighten its own monetary policy in coming months. Because financial markets are highly interconnected, a tightening in credit conditions in the world’s largest economy influences markets around the globe.

Any increase would cause headaches for Europe, where the economy is still weak and needs help from low credit costs. The eurozone has only begun a hesitant recovery, growing 0.3 percent in the second quarter after six quarters of recession.

In the hope of keeping the market rates down, the ECB has said its key interest rate will stay at the current level or lower “for an extended period.” If market rates don’t respond and stay low, the ECB could try to influence the market through another LTRO.

So far, Draghi’s talk about another LTRO seems to have had some effect by itself. Interest rates in the open market have fallen after he and other ECB officials hinted that the ECB might act.

Those rates have also fallen because the Fed unexpectedly delayed its decision to rein in — or ‘taper’ — its monetary stimulus. The Fed’s hesitation has given Draghi some breathing room.

“The ECB can probably afford to wait for a little longer following the Fed’s non-taper decision,” said Frederick Ducrozet, analyst at Credit Agricole. He said the ECB could wait until December to signal its move and then conduct it in March of next year.

Michael Schubert of Commerzbank predicted rate expectations will not rise again and that it’s “more likely that the ECB will offer no further LTRO.”

There are other factors suggesting the ECB may decide against anther LTRO.

Some banks used the cheap loans not to lend more businesses — as the ECB had hoped — but to buy higher-yielding, risky bonds issued by eurozone governments. That has the unwelcome effect of tightening the link between banks and troubled government finances. That link worsened the eurozone’s debt crisis over the past three years, and eurozone officials are trying to break it.

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