Financial Times Editorial Comment: Fighting recession in the eurozone

Financial Times Editorial Comment: Fighting recession in the eurozone
Copyright The Financial Times Limited 2009
Published: May 7 2009 18:51 | Last updated: May 7 2009 18:51
http://www.ft.com/cms/s/0/6e14afb6-3b2e-11de-ba91-00144feabdc0.html


The European Central Bank has repeatedly had to rebut accusations of being behind the curve. Thursday’s announcement that it will buy bonds may appease those who want it to follow the unconventional footsteps of the Federal Reserve and the Bank of England. The truth is that eurozone monetary policy is reaching the limits of what it can do.

Complaints that the ECB has been doing too little too late are legitimate but overdone. Its main refinancing rate remains well above the sterling and dollar policy rates, even after Thursday’s cut to 1 per cent. But markets are taking their cue from the deposit rate: the ECB’s floor, which it kept unchanged at 0.25 per cent. Therefore many market rates are now lower in the euro area than elsewhere.

Despite resisting quantitative easing, the ECB has pioneered other unconventional policies, such as providing unlimited liquidity to banks at the main rate, and broadening the collateral it accepts. That support was on Thursday extended to maturities up to 12 months.

So although the ECB has taken its time, the difference with its sister banks lies less in what each has done and more in what each of them can possibly achieve. The ECB is responsible for 16 countries with widely differing problems: over-indebted consumers; overstretched banks; or evaporated export demand. Tailoring a single monetary policy to such divergent conditions is inherently imperfect. The ECB is hardly doing too much, but it faces particular challenges in loosening monetary policy further when interest rates are near zero.

In the US, buying bonds is a risky but plausible strategy to resuscitate securitisation. But in Europe, where conventional loans comprise the bulk of credit, banks must be made to lend again. As with the ECB’s earlier measures, its goal in deciding to buy covered bonds (which are issued by banks) is to secure banks’ funding. It is loath even to call this quantitative easing: since banks can already post covered bonds as collateral, the policy may indeed not affect the money supply by much.

The ECB’s influence on lending is in any case waning. Europe’s banks have yet to own up to their losses; the inevitable day of reckoning will push them to shrink balance sheets. And as the recession deepens, fewer borrowers approach banks and those that do are less creditworthy. Lending is now as constrained by demand as by a supply squeeze.

The ECB must keep doing what it can to loosen monetary conditions. But it must also make clear the need to recapitalise banks and stimulate demand further. The ECB cannot beat this recession alone.