ECB leaves interest rates on hold at 1% - Trichet downgrades growth forecasts

ECB leaves interest rates on hold at 1% - Trichet downgrades growth forecasts
By Ralph Atkins in Frankfurt and David Oakley in London
Copyright The Financial Times Limited 2009
Published: June 4 2009 12:45 | Last updated: June 4 2009 14:56
http://www.ft.com/cms/s/0/2a2fbd36-50f5-11de-8922-00144feabdc0.html


Eurozone official interest rates have been left unchanged at 1 per cent by the European Central Bank as it waits to see the impact of measures taken to combat continental Europe’s worst recession since the second world war.

Jean-Claude Trichet, ECB president, had signalled last month that eurozone borrowing costs would remain at the current historic low. Instead attention is likely to focus on the ECB’s plans to buy €60bn in “covered bonds,” which are issued by banks and backed by public sector loans or mortgages.

The plan, which was agreed in principle at May’s ECB governing council meeting, marked a first step towards following the asset purchase programmes unveiled by the Bank of England and US Federal Reserve.

The plan was controversial within the ECB governing council and the move prompted a surprise attack on the central bank this week from Angela Merkel, the German chancellor.

Breaking a German political tradition of not criticising the central bank, Ms Merkel argued that the ECB had “bowed to international pressure with its purchase of covered bonds”. She warned that unconventional policies being pursued by monetary authorities worldwide risked exacerbating the economic crisis.

However, Mr Trichet stressed at the press conference following Thursday’s rate decision that the move to buy covered bonds would not hamper the central bank’s pursuit of price stability. He said the central bank’s focus remained on keeping inflation in line with its target of an annual rate “below but close” to 2 per cent.

He also stressed that the bank remained fiercely protective of its independence, adding that Ms Merkel told him in a telephone call that she fully respected this.

“I was extremely happy that the chancellor could confirm that she was fully backing our independence and appreciated what we were doing,” he said.

Ms Merkel’s comments reflected widespread fears in Germany that the actions taken by the world’s central banks are creating longer term inflation risks. But for now the ECB faces the opposite problem.

At zero per cent in May – the lowest in the region at least since comparable records began in 1991 – eurozone inflation is undershooting the central bank’s target. Mr Trichet has admitted inflation will turn negative in coming months.

At the press conference, he outlined more details of the covered bond programme, which will involve direct purchases of the securities in the primary and secondary markets. The bank will also buy bonds across the whole eurozone. The bonds will be purchased between July this year and June 2010.

The bonds must be eligible for use as collateral in the ECB’s financing operations and have value of about €500m, with a minimum value of €100m. They must also have a minimum rating of double A by one or more of the three main ratings agencies, Fitch, Moody’s and Standard & Poor’s.

Mr Trichet said the bank would probably buy bonds between three and 10 years in maturity, adding that the exit strategy was a key part of the success of the programme.

He also said the bank was following closely the situation in Latvia, where a debt auction failed this week amid worries that the country would have to devalue its currency, the lat, which is pegged against the euro.

Mr Trichet now expects activity in the 16-country eurozone to decline at much less negative rates after a stabilisation phase, adding that positive quarterly rates are expected in mid-2010.

Annual real GDP growth will range between minus 5.1 per cent and minus 4.1 per cent in 2009 and between minus 1.0 per cent and plus 0.4 per cent in 2010, he said, with macroeconomic projection ranges having been revised downward in particular for 2009.

Since the intensification of the global financial market crisis last October, the ECB has cut its main interest rate by 325 basis points. Mr Trichet has signalled wariness about allowing official borrowing cost to fall to zero. But he has not ruled out further interest rate cuts – or an expansion of the covered bond purchase scheme to cover other assets.

The ECB’s next move will depend largely on the eurozone’s economic prospects and the resulting inflation pressures. Since late last year, economic activity has contracted sharply. The 2.5 per cent reduction in eurozone GDP in the first quarter of this year was greater than the falls reported in the UK and US. But forward-looking indicators, for instance of economic confidence, have suggested that the pace of contraction has slowed markedly more recently.