ECB to hold fire, Fed loads second stimulus round


Yahoo | AFP | 31/10/2010

The European Central Bank governing council meets this week after European leaders moved to shore up eurozone stability and as the US Federal Reserve mulls a second round of monetary stimulus. The ECB is sure to maintain its main lending rate at a record low of 1.0 percent, analysts say, while focusing potentially tense talks on whether to continue unwinding its own unconventional measures.

euro-unionA rift between ECB governors has opened over pursuing purchases of eurozone government debt, with German central bank chief Axel Weber saying he will stick to his guns even if it means passing on a chance to be the next ECB president. Weber insists the scheme should be phased out and said last week: "If that’s going to have implications for my future career, then I’d be happy to live with those consequences."

Commerbank economist Michael Schubert said: "Behind closed doors … the council is likely to discuss how to continue its gradual exit from unconventional measures" some eurozone banks have come to depend upon. "Discussions could become even more heated at Thursday’s meeting," he added.

Growth in powerhouse Germany is strong now but Greece is still in recession and faces an unsettled political situation that could worsen its debt crisis. In London meanwhile, the Bank of England is expected to maintain its main interest rate at a record low of 0.50 percent on Thursday.

In the United States, the Fed appears set to launch another round of so-called quantitative easing, essentially printing money to stimulate the economy, a decision that has polarized its directors too. As the US gambles that what is called QE2 will pay off, European Union leaders were persuaded by an "impassioned" German Chancellor Angela Merkel to work on a permanent crisis mechanism for distressed eurozone states.

A long-term rescue fund could help indebted countries but the EU would also adopt somewhat tougher fiscal rules that could cut two ways for the ECB, Royal Bank of Scotland economist Jacques Cailloux noted. Part of the Lisbon Treaty that could be revised "is close to the section detailing the mandate of the ECB which is likely to make the bank very nervous," Cailloux commented.

The ECB has pressed EU governments to make a "quantum leap" in governance to ensure the eurozone stands on a solid foundation, and ECB president Jean-Claude Trichet has voiced rare public opposition to parts of a mooted EU agreement. "The ECB has done nothing to hide its disappointment on the agreement reached by euro area finance ministers on the reform of economic governance," UniCredit economists noted.

Deutsche Bank economist Gilles Moec said: "The ECB may be tempted to preemptively normalize its monetary framework at a fast pace to force a reaction from the governments in tackling their fiscal issues." He warned such a move "could be quite disruptive." The eurozone economic climate is improving but its recovery is not rock solid and many indebted members have had to approve austerity budgets that could hamper growth.

Inflation stands at 1.9 percent, basically the ECB’s target, but though unemployment is falling in Germany, it is at a record 10.1 percent for the eurozone as a whole. Key bank lending appears to be improving and business confidence hit a three-year high in October, though consumer expectations were flat and volatile German retail sales figures showed the steepest drop since the recession.

The euro has risen in value to around 1.38 dollars as markets watch the ECB slowly tighten monetary policy while the Fed signals it is ready to pump more cash into the US economy. The ECB’s main interest rate should stay at 1.0 percent until the bank sees "confirmation of a self-sustaining recovery," UBS analysts said.

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