Bloomberg News

Trichet May Play Rate Card as Germany Adds to Greek Pressure

June 09, 2011

(Updates with bond yields in sixth paragraph.)

June 9 (Bloomberg) -- European Central Bank President Jean- Claude Trichet may today play the interest-rate card and signal to European governments that the euro region’s debt crisis is theirs to solve.

Two days after German Finance Minister Wolfgang Schaeuble opened a rift with the ECB over how to fix Greece’s debt crisis, Trichet is likely to signal that the ECB is ready to raise interest rates for a second time in three months in July, a Bloomberg News survey showed. The central bank today will keep its benchmark at 1.25 percent, a separate survey showed.

The latest phase of the Greek crisis risks exacerbating tensions between the ECB and the German government. While Schaeuble said in a letter published June 7 that bondholders should be stung as part of a second Greek bailout package, the ECB argues that such a step could spark a new wave of financial turmoil and insists it’s ready to press on with raising rates.

“If there’s a hardening of attitudes between Germany and the ECB, the ECB are just going to dig in their heels and insist on their independence,” said James Nixon, chief European economist at Societe Generale SA in London. “They’re going to tell European governments it’s their problem and they can clear up the mess.”

Lehman ‘Catastrophe’

Trichet, whose eight-year term expires at the end of October, will hold a press conference at 2:30 p.m. in Frankfurt. The central bank will also publish its latest economic forecasts for this year and next.

The yield on German 10-year bonds was little changed at 3.06 percent as of 9:25 a.m. in Frankfurt. Greece’s two-year bonds rose, pushing the yield down 40 basis points to 23.53 percent.

The ECB and the German government are at loggerheads over how much pain private-sector creditors should bear in any pan- European deal that would tackle Greece’s debt load.

In the letter to Trichet and other finance officials, Schaeuble said maturities on Greek bonds should be extended seven years to give the debt-wracked nation time to overhaul its economy. Any agreement on aid at a ministers’ meeting on June 20 “has to include a clear mandate” to “initiate the process of involving holders of Greek bonds,” he wrote.

For its part, the ECB has opposed anything beyond a voluntary rollover of debt to avoid what European Union Economic and Monetary Affairs Commissioner Olli Rehn has called a “Lehman Brothers catastrophe.” A swap offering investors terms that are “worse” than those of existing securities would constitute a coercive or distressed exchange, and be considered a default, Fitch Ratings said earlier this week.

ECB ‘Frustrated’

While Trichet has said the so-called Vienna initiative approach, which would see bondholders commit to purchase new bonds after their existing holdings had matured, was something “the ECB would consider appropriate,” Schaeuble called for a solution going beyond that.

“The ECB is frustrated that there are these irrational politicians that they can’t control,” said Jens Sondergaard, an economist at Nomura International in London. Greece’s “doomsday scenario is that they default, they don’t get the payments and all bets are off.”

A year after approving a 110 billion-euro ($160 billion) bailout for Greece, European leaders and the International Monetary Fund are working on a second funding package. Schaeuble told lawmakers yesterday that Greece’s financing needs amount to 90 billion euros through 2014, according to two people who attended his briefing.

The EU and the IMF can’t make a pending bailout payment to Greece until a plan to meet the country’s financing needs for 2012 is worked out, according to a report published yesterday. The country’s financing costs remain “prohibitive,” making it impossible for Greece to return to markets next year, it said.

Greek Downgrade

With governments struggling to contain the region’s debt crisis, the ECB may keep providing lenders with unlimited liquidity. Banks in Greece, Ireland and Portugal have been reliant on central bank funding after lending dried up.

“You cannot separate monetary policy and the problems of the periphery completely, but you can to a certain extent,” said Holger Schmieding, Chief Economist at Joh. Berenberg, Gossler & Co. in London. “It’s likely they’ll indicate a rate hike and keep most of the other liquidity measures in place.”

Moody’s on June 1 downgraded Greece to Caa1 from B1, putting it on the same level as Cuba after policy makers considered asking investors to reinvest in new Greek debt when existing bonds mature. Greece said the move “overlooks” its commitment to meeting its 2011 fiscal target as well as an “accelerated” state-asset sale program.

Investors Unconvinced

Investors remain unconvinced. Greek 10-year bonds yield almost 16 percent and the country is the most expensive in the world to insure against default, at about 1,500 basis points, according to CMA prices. The yield investors demand to hold Greek 10-year bonds instead of benchmark German bunds widened for the first day in four yesterday.

The ECB is “desperate to avoid the debt crisis becoming a euro crisis,” said Steven Barrow, an economist at Standard Bank Plc in London. “The best way to do this is to prove its independence and raise rates. Do I think this is the best way? No. Do I know the ECB well enough to know that they will do it? Yes.”

Inflation Concern

ECB policy makers have signaled concern about oil-driven inflation feeding into wage demands and sparking so-called second-round effects. Italy’s Mario Draghi, the nominee to take take over from Trichet, said on May 31 that there’s now a “greater need to proceed with monetary policy normalization.”

Trichet today may pave the way for a rate increase in July by calling for “strong vigilance” on price pressures. The ECB in April raised borrowing costs from a record low for the first time in almost three years to fight inflation threats.

While euro-region inflation weakened to 2.7 percent in May from 2.8 percent in the previous month after energy costs retreated, the central bank will probably increase its full-year estimate to 2.7 percent from 2.3 percent projected in March and also raise its growth estimate, said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London.

“Assuming that the Greek problem doesn’t become systemic, the ECB will press on” with raising rates, said Ken Wattret, chief euro-region economist at BNP Paribas SA in London. “Greece is only a risk scenario for the ECB.”

--With assistance from Lucy Meakin in London, Brian Parkin, Rainer Buergin and Alan Crawford in Berlin and Jana Randow in Frankfurt. Editors: Simone Meier, Craig Stirling

To contact the reporter on this story: Jeff Black in Frankfurt jblack25@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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