European Central Bank split on policy

Bloomberg

Jean-Claude Trichet is facing the biggest split on the European Central Bank’s Governing Council in his six years as president.

Months after other central banks cut their key interest rates close to zero and started pumping money into their economies, the ECB’s 22-member council is still divided over whether to follow suit. The stand-off has delayed new measures to stem the euro region’s worst recession since World War II.

"I fear the ECB will be bogged down by internal squabble," said Ken Wattret, chief euro region economist at BNP Paribas in London. "It seems to be turning into a battle between the activists and those with a more conservative persuasion. It’s the biggest dispute under Trichet."

His search for consensus is being thwarted by a split so great that three different views have been aired in the past week alone. In one corner, Germany’s Axel Weber has ruled out cutting the ECB’s key rate below 1 percent and said he doesn’t want to buy debt securities.

In another, Greece’s George Provopoulos and Athanasios Orphanides of Greek Cyprus want to keep open the option of deeper rate reductions and asset purchases to fight the risk of deflation.

Between them sits Austria’s Ewald Nowotny. While agreeing with Weber that the main rate shouldn’t go below 1 percent, he argues debt purchases are "sensible."

Trichet yesterday denied a split, saying in Tokyo: "We have a very united Governing Council."

Nevertheless, the debate prompted the ECB to this month cut its benchmark less than economists had forecast, by a quarter point to 1.25 percent, and delay a decision on new measures until May. While Trichet has signaled another quarter-point rate cut is likely, he has declined to comment on what new tools the bank will unveil as officials continue to bicker.

"Since it’s taking the ECB so long to agree, I wouldn’t have high hopes of a major surprise at the May meeting," said Julian Callow, chief European economist at Barclays Capital in London. "Asset purchases are something they will have to consider at a later stage. They won’t resolve this dispute before summer."

Euro declines
Trichet said in Tokyo that "it is important not to create or encourage expectations" about the next rate meeting. The euro extended declines after Trichet’s comments, dropping to $1.3076. The currency lost 1.3 percent against the greenback since April 1 and 6.9 percent since the start of the year.

Outright opposition from Weber’s Bundesbank could make it harder for Trichet to negotiate a compromise. Weber represents Europe’s largest economy on the council and a central bank whose inflation-fighting mandate served as a blueprint for the ECB itself.

"He’s a Bundesbank president, he’s very influential," said Nick Kounis, chief European economist at Fortis in Amsterdam. "I always see his remarks as a very good indication of what happens next."

Weber said recently that cutting the ECB’s benchmark rate too close to its overnight deposit rate would reduce the incentive for banks to lend to each other, creating the risk of the interbank money market becoming "completely paralyzed."

While not ruling out the purchase of corporate debt, Weber said it shouldn’t be a priority for an economy that is primarily bank-financed. Instead, he favors extending the maturities of the ECB’s loans to banks from the current six-month limit to ease credit concerns.

Longer-term loans may require the ECB to signal that the benchmark rate won’t drop any further. That’s because banks would be reluctant to borrow for longer terms if they thought they could get money cheaper in the future.

"It’s necessary that we announce a refinancing framework that can be relied upon for a certain period of time," Weber said. "That includes the medium-term level for the main refinancing rate."

There are signs Weber is gaining support. Jose Manuel Gonzalez-Paramo, one of the ECB’s six Executive Board members, said Thursday the margin for a further rate reduction is "very moderate" and excessively low rates have "disadvantages."

"It’s a done deal" that the ECB will extend the maturities of loans to banks, said Aurelio Maccario, chief euro-area economist at UniCredit MIB in Milan. "However, we fear that this won’t suffice and that eventually the ECB may be forced to expand its balance sheet via an asset-purchase program."

The Federal Reserve, Bank of England and Bank of Japan have already cut rates close to zero and are buying government and corporate debt. Orphanides has spearheaded the argument for a more expansive monetary policy at the ECB.