ECB May Dig Deeper Into Toolbox as Leaders Seek Fiscal Union

ECB May Dig Deeper Into Crisis Toolbox
European Central Bank's (ECB) headquarters in Frankfurt, Germany. Photographer: Hannelore Foerster/Bloomberg

The European Central Bank may delve deeper into its toolbox today to stimulate bank lending and fight off a recession as Europe’s leaders gather to lay the foundations for a fiscal union.

ECB policy makers meeting in Frankfurt will cut the benchmark interest rate by a quarter percentage point to 1 percent, according to 54 of 58 economists in a Bloomberg News survey. They may also loosen collateral criteria to give banks greater access to cheap cash and offer longer-term loans, said three euro-area officials with knowledge of the deliberations.

Hours later, Europe’s leaders will convene in Brussels for talks to frame the fifth “comprehensive” solution in 19 months to a debt crisis that’s left Germany and France facing the threat of losing their AAA rating from Standard & Poor’s. The ECB says that governments must address the cause of the turmoil as it focuses on getting banks lending again rather than increasing purchases of indebted nations’ bonds.

“It’s yet another date with destiny in the euro area,” said Julian Callow, chief European economist at Barclays Capital in London. “It’s clear there won’t be the ultimate resolution, but the proposals are going in the right direction. The markets seem to have finally understood that in the ECB’s eyes it’s up to governments to solve it, and it’s worth noting that it’s doing a lot on the banking side.”

Stocks Advance

European stocks rose for the first time in three days on speculation policy makers will reduce borrowing costs and introduce new ways to tackle the debt crisis. The Stoxx Europe 600 Index advanced 0.2 percent as of 9:30 a.m. in London. The euro was little changed at $1.3400.

The ECB announces its rate decision at 1:45 p.m. in Frankfurt and President Mario Draghi holds a press conference 45 minutes later. European Union leaders will meet for dinner at 7.30 p.m. in Brussels for talks that will continue tomorrow.

Separately, the Bank of England will keep the size of its asset-purchase program unchanged at 275 billion pounds ($432 billion) and leave its key rate at 0.5 percent, according to another survey of economists. That decision is due at noon in London.

The ECB’s insistence that governments take measures to restore investor confidence appears to have paid dividends, with Italian and Spanish yields plunging after Germany and France agreed to move the 17-nation euro area toward a fiscal union, a stance they reiterated yesterday.

Joint Letter

French President Nicolas Sarkozy and German Chancellor Angela Merkel are proposing to amend European treaties to tighten controls on budgets. In a joint letter to EU President Herman Van Rompuy, the leaders said they want a decision by the close of their summit tomorrow so that the measures can be ready by March next year.

Still, Germany rejects proposals to combine the region’s current and permanent rescue funds, a German government official told reporters in Berlin yesterday on condition of anonymity.

The ECB must step up its bond purchases to stamp out the crisis, said Angel Gurria, secretary general of the Organization for Economic Cooperation and Development.

“The ECB is the ultimate weapon” and “has to be part of the solution,” he said yesterday in an interview in Durban, South Africa. “You are using a slingshot, where is the bazooka?”

‘Other Elements’

Draghi said on Dec. 1 that the ECB’s bond purchases “can only be limited.” If governments move toward a “fiscal compact,” there may be room for “other elements,” he said, without elaborating.

“Markets are clearly hoping for any signs of future ECB bond buys,” said Jens Sondergaard, senior economist at Nomura International Plc in London. “We think they’ll be disappointed. They won’t endorse or commit to anything before they see what the outcome of the EU summit is.”

Draghi did indicate a willingness to address signs of a credit squeeze, which falls squarely within the ECB’s remit.

The central bank has “observed serious credit tightening” and is “aware of the continuing difficulties for banks, due to the stress on sovereign bonds, the tightness of funding markets and scarcity of eligible collateral in some financial segments,” Draghi said.

Collateral Pool

Policy makers may broaden the pool of eligible collateral for ECB loans by loosening rules governing the use of asset-backed securities, said officials speaking on condition of anonymity. They may also increase the amount of uncovered bank bonds that can constitute a lender’s collateral portfolio from the current 10 percent limit, they said.

The ECB is already lending banks as much money as they want against eligible collateral for periods of up to a year. It is likely to add two-year loans to its arsenal, two officials said. While a three-year loan has been discussed, it is unlikely at this stage, they said.

One official said longer-term loans might encourage banks to lend to companies and households, and they would also help financial institutions meet new Basel rules on holding longer-term liquidity.

Today’s meeting is the ECB’s last scheduled opportunity to take policy action this year. It will be accompanied by publication of the central bank’s latest projections, including a 2013 inflation forecast that may justify further monetary stimulus.

Economic Outlook

Draghi said last week that the ECB’s goal is to maintain price stability “in either direction,” suggesting it would act as forcefully to prevent a significant undershooting of its 2 percent ceiling as it would to stop an overshooting.

“This applies to both the setting of official interest rates and the implementation of non-standard measures,” Draghi said.

One official said the economic outlook has deteriorated markedly since Draghi said on Nov. 3 that the ECB expected a “mild recession.”

The OECD said Nov. 28 that growing doubts about the survival of Europe’s monetary union has caused global growth to stall and represents the main risk to the world economy.

The euro area itself is already in a “mild” recession, with the region set to register growth of 1.6 percent this year and just 0.2 percent in 2012, the OECD said.

-- With assistance from Andres Martinez in Durban and Kristian Siedenburg in Vienna. Editors: Matthew Brockett, Craig Stirling

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