Bloomberg News

Trichet’s Legacy Still in Play as Final Rate Meeting Looms

October 06, 2011

(Updates with Bank of England decision in 10th paragraph. See EXT4 <GO> for more on the European debt crisis.)

Oct. 6 (Bloomberg) -- Jean-Claude Trichet’s legacy is still being scripted as he enters the final weeks of his eight-year term at the helm of the European Central Bank.

Chairing his last rate-setting meeting in Berlin today, Trichet may be forced to take the ECB further into uncharted waters before he hands the presidency to Italy’s Mario Draghi on Nov. 1, economists said. With Greece edging closer to default, the central bank is under pressure to deploy unlimited firepower to shore up the region’s bond markets either on its own or through Europe’s bailout fund.

Other options include offering distressed banks longer-term loans and even cutting interest rates as the sovereign debt crisis threatens the survival of the euro -- the currency Trichet has championed as a symbol of European unity.

“Who would have thought at the beginning of the year that Trichet would have to play fire brigade yet again at his very last rate meeting,” said Carsten Brzeski, senior economist at ING Group NV in Brussels. “Instead of celebrating a legacy of price stability and having saved the euro after the Lehman crash three years ago, he finds himself having to bail out the politicians and banks once again.”

In The Vanguard

It has fallen to Trichet to lead the battle against the crisis as lawmakers squabble over their response. His push to resume government bond purchases in August split the ECB’s 23- member Governing Council and led to the resignation of chief economist Juergen Stark. Trichet’s final decisions in office may be among the most critical for the future of the euro.

European stocks advanced on speculation leaders will reach agreement on how to contain the debt crisis. The Stoxx Europe 600 Index climbed 1.7 percent to 227.84 at 12:08 p.m. in London after a 3.1 percent gain yesterday.

“Trichet holds Europe’s destiny in his hands at this point in time,” said Julian Callow, chief European economist at Barclays Capital in London, who predicts a quarter-point rate cut today. “It would be a colossal disaster if we had a prolonged recession in the euro area. Policy makers have to throw the kitchen sink at it to prevent it.”

Economists Divided

While most economists say the ECB will keep its benchmark rate at 1.5 percent today, five of 52 in a Bloomberg News survey predict a cut to 1.25 percent and six expect a reduction to 1 percent. It’s the first time in 16 months that economists in the survey haven’t been unanimous.

The ECB announces its rate decision at 1:45 p.m. and Trichet gives a press conference 45 minutes later. ECB officials hold two policy meetings a year outside Frankfurt.

The Bank of England today unexpectedly expanded its bond- purchase plan to 275 billion pounds ($421 billion) from 200 billion pounds as government budget cuts and Europe’s debt crisis jeopardize Britain’s economic recovery. The nine-member Monetary Policy Committee led by Mervyn King kept its key rate at a record low of 0.5 percent.

ECB policy makers, who have raised borrowing costs twice this year, have signaled they may resist calls for a rate cut and opt instead to increase the supply of cash to euro-area banks to prevent a liquidity crunch.

Austria’s Ewald Nowotny and Belgium’s Luc Coene said the ECB may reintroduce 12-month loans, a measure last used at the end of 2009. The ECB will also discuss reviving its covered-bond purchase program to kick-start term funding markets, a euro-area central bank official told Bloomberg News on condition of anonymity.

‘Better Suited’

A rate cut “would seem premature” and “have only a short-lived impact on confidence,” said Elwin de Groot, senior market economist at Rabobank Nederland in Utrecht. “Unconventional measures seem better suited to deal with the current funding challenges in the banking system, which are largely the result of the high uncertainty surrounding the potential impact of an uncontrolled default of Greece.”

Trichet, 68, is stepping down just as Europe’s sovereign debt crisis spills into the financial sector after governments failed to prevent contagion from Greece to the euro area’s core. Market borrowing costs in Italy and Spain, the region’s third and fourth-largest economies, have jumped as investors fret about their public finances.

Moody’s Investors Service on Oct. 4 cut Italy’s credit rating for the first time in almost two decades on concern its economic growth may be too weak to enable the reduction of the region’s second-largest debt load.

EFSF Proposal

While Trichet has stepped into the breach with ECB bond purchases, he may baulk at some of the proposals governments are considering to beef up their rescue fund, the European Financial Stability Facility.

One idea is to grant the EFSF a banking license so that it can borrow from the ECB to fund purchases of government bonds. Bundesbank President Jens Weidmann has said that would amount to printing money to fund distressed euro-area nations, and Trichet told lawmakers in Brussels on Oct. 4 that he’s “not in favor” of the plan.

Andrew Bosomworth, executive vice-president and senior portfolio manager at Pacific Investment Management Company in Munich, said the ECB should drop its resistance to a Greek debt restructuring. Trichet has insisted that any private-sector involvement in a restructuring must be voluntary.

“By failing to cleanse the banking system of unrealized losses, the ECB is leading Europe down the same path as Japan’s lost decade of growth,” Bosomworth said.

Growth slowed to 0.2 percent in the second quarter from 0.8 percent in the first. The ECB last month cut its growth forecasts to 1.6 percent from 1.9 percent for 2011 and to 1.3 percent from 1.7 percent for 2012.

At the same time, inflation in the 17-nation euro region unexpectedly accelerated to 3 percent in September, the fastest pace in three years and well above the ECB’s 2 percent limit.

Trichet told European parliamentarians on Oct. 4 it’s “sometimes forgotten” that the bank’s primary objective is to “maintain price stability.”

--With assistance from Kristian Siedenburg in Budapest. Editors: Matthew Brockett, Simone Meier

To contact the reporters on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net; Gabi Thesing in London at gthesing@bloomberg.net

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


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