ECB May Delay Exit Again as EU Bailout of Ireland Fails to Stem Contagion
ECB May Be Forced to Delay Exit Again, Debt Crisis Escalates
Hannelore Foerster/Bloomberg
While the ECB has withdrawn some of its crisis measures, such as 12- and 6-month loans to banks, it back-peddled on its exit in May after Greece’s debt crisis threatened the survival of the euro.
While the ECB has withdrawn some of its crisis measures, such as 12- and 6-month loans to banks, it back-peddled on its exit in May after Greece’s debt crisis threatened the survival of the euro. Photographer: Hannelore Foerster/Bloomberg
Nov. 24 (Bloomberg) -- Vicky Pryce, senior managing director at FTI Consulting Inc., talks about Ireland's four-year deficit-reduction plan and the outlook for the euro-region economy. Pryce speaks with Margaret Brennan on Bloomberg Television's "InBusiness." (Source: Bloomberg)
The European Central Bank may have to delay its exit from emergency measures again as Ireland’s bailout fails to stem the region’s sovereign debt crisis.
Investors are dumping Spanish and Portuguese bonds on concern they will have to follow Ireland and Greece in asking for European Union bailouts, making it more difficult for the ECB to proceed with its withdrawal of liquidity support for banks. Some economists now doubt the ECB will be able to signal a move back to limited auctions of three-month loans, which they regard as the next likely step in the bank’s exit, when policy makers meet next week in Frankfurt.
“We can no longer be very categorical on this point given the engulfing crisis in the periphery and the desire of the ECB to avoid exacerbating it,” said Julian Callow, chief European economist at Barclays Capital in London. “We should prepare for the distinct possibility that the ECB realizes the timing would be bad and so avoids taking actions that could inflame an already inflammatory situation.”
Surging bond yields in Greece, Ireland, Portugal and Spain suggest investors are losing confidence in the ability of European leaders to contain the debt crisis, even after they agreed to rescue Ireland. At the same time, Germany’s economy expanded at the fastest pace since reunification in the second quarter and a report yesterday showed business confidence jumped to a record this month. That’s prompting ECB policy makers including Axel Weber, Juergen Stark and Yves Mersch to say they’re anxious to proceed with the withdrawal of stimulus.
December Rendezvous
President Jean-Claude Trichet has said a decision on the next step will be made at the Dec. 2 meeting. Finnish finance minister Jyrki Katainen said Nov. 22 that the ECB should not withdraw support measures until Ireland has restructured its banks. At the moment, the ECB lends banks all the cash they need for periods of one week, one month and three months at its benchmark rate of 1 percent.
The ECB’s 22 council members must weigh the risk of destabilizing Europe’s debt-strapped economies by making it more costly for their banks to borrow against the danger of over- stimulating faster-growing countries like Germany by leaving policy loose for too long.
“It’s such a close call,” said Carsten Brzeski, an economist at ING Group in Brussels who used to work at the European Commission. “The ECB doesn’t want to be seen to be held hostage by markets and politicians. At the same time, going ahead with the exit on non-conventional measures will be viewed as a signal for tighter policy going forward, and that is going to upset markets.”
Exit Interrupted
While the ECB has withdrawn some of its crisis measures, such as 12- and 6-month loans to banks, it back-pedaled on its exit in May after Greece’s debt crisis threatened the survival of the euro. The central bank cancelled plans to end its provision of unlimited three-month loans and also started buying government bonds to calm markets.
German Chancellor Angela Merkel’s push for investors to foot more of the bill in future EU bailouts has sparked a new selloff on bond markets, making it more expensive for governments to refinance their debts and forcing Ireland to seek rescue funds on Nov. 21.
The extra yield demanded by investors to hold Spanish 10- year bonds over German bunds rose to a record 249 basis points yesterday, while the Irish yield spread widened for a fourth day, climbing to 618 basis points. That’s close to a record 652 basis points set on Nov. 11.
Prudent Exit
ECB Executive Board member Stark nevertheless reiterated this week that the bank intends to proceed with its exit. While there are tensions in some areas, confidence is generally returning to financial markets, he said.
Luxembourg’s Mersch told CNBC in an interview broadcast yesterday that the ECB will “continue on our gradual and prudent exit strategy,” while Nout Wellink of the Netherlands said banks can’t rely on ECB funds forever, Trends magazine reported.
“The ECB will probably have to think hard about the strategy it is pursuing because to some extent it is those discussions about the need to go fairly fast on monetary policy normalization that triggered this kind of market turmoil,” said Gilles Moec, an economist at Deutsche Bank AG in London.
Still, “the ECB is reaching the limit of its mandate,” said Guillaume Menuet, senior European economist at Bank of America Merrill Lynch in London. Policy makers “will probably go back to a variable-rate tender on the three-month loan on a generous allocation to placate the more hawkish members.”
Ken Wattret, chief euro-area economist at BNP Paribas in London, said he wouldn’t be surprised if the ECB took another exit step next week, “given what we are hearing from some council members.”
“But common sense might prevail,” he said.
To contact the reporter on this story: Gabi Thesing in London at gthesing@bloomberg.net
To contact the editor responsible for this story: John Fraher at jfraher@bloomberg.net
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