The European Central Bank (ECB) left its benchmark interest rate at 1 per cent, a record low, and will probably hold off unwinding any more emergency lending measures as Greece’s budget deficit takes center stage.
ECB President Jean-Claude Trichet holds a press conference at 2:30 pm in Frankfurt to explain Thursday’s rate decision, which was predicted by all 55 economists in a Bloomberg News survey. Trichet has indicated he’ll wait for new growth and inflation forecasts in March before deciding when to step up the withdrawal of measures used to battle the financial crisis.
“I imagine the Greek situation will be the main topic of discussion on Thursday,” said Nick Kounis, chief European economist at Fortis in Amsterdam. “They have to think about the consequences for the rest of the region, so they will continue to take a rather hard line on Greece.”
Rising unemployment and concern that Greece’s fiscal problems could spread through the 16-nation euro area complicate the ECB’s efforts to return the economy to health. The Greek government is struggling to convince policy makers and investors that it can cut its deficit from 12.7 per cent of gross domestic product (GDP) last year to below the European Union’s 3 per cent limit by 2012.
Clear message
“Trichet’s message will be quite clear — Greece has to get its finances in order,” said Ken Wattret, chief euro-area economist at BNP Paribas in London. “But if you consolidate in such a rush, you very likely generate a recession. Radical financial tightening doesn’t usually go hand in hand with robust growth.”
The Bank of England earlier kept its key rate at a record low of 0.5 per cent and paused its bond-purchase programme.
Australia’s central bank this week unexpectedly paused in its rate-tightening cycle after last year’s increases drove up the nation’s currency, hurting exports. The Federal Reserve last week restated its intention to keep interest rates near zero for an “extended period,” saying the pace of economic recovery “is likely to be moderate for a time.”
While the ECB isn’t forecast to raise borrowing costs before the fourth quarter, it has started to unwind its emergency lending programs. The central bank in December tightened the terms of its final tender of 12-month loans, one of its flagship measures during the crisis, and said it will discontinue its six-month loans after March.
Next step
The ECB is still lending commercial banks as much money as they need at its benchmark rate, rather than having them bid for the cash, in an effort to get credit flowing through the economy.
Council members Axel Weber and Yves Mersch have indicated the next step in the ECB’s exit strategy is likely to be a return to an auction procedure in some of its refinancing operations, which may be announced after the March policy meeting.
“The ECB is on track for a complete normalisation of its lending operations by the third quarter,” said Laurent Bilke, a former ECB economist now at Nomura International Plc in London. “That’s a prerequisite and will pave the way for the first rate hike” in November, he said.
The euro-area economy will grow 0.8 per cent this year and 1.2 per cent in 2011, according to the ECB’s December forecasts. It contracted 4 per cent last year, the European Commission estimates.
‘Not easy’
Financial belt-tightening across the region may damp the recovery as governments rein in spending to reduce budget shortfalls incurred during the recession. The euro has dropped 8.5 per cent since November 25, to $1.3840 on Thursday.
European Union (EU) Economic and Monetary Affairs Commissioner Joaquin Almunia yesterday backed Greece’s consolidation program while saying its implementation “is not easy.”
Scepticism about Greece’s consolidation plans last week drove the premium that investors demand to hold Greek 10-year bonds instead of benchmark German bunds to almost 400 basis points, the highest since before the euro was launched in 1999.
Spanish and Portuguese bond yields have also risen amid concern those nations are facing similar challenges.
