Trichet Faces `Annus Horribilis' as Crisis Tests ECB
Jean-Claude Trichet’s final year at the helm of the European Central Bank may be his toughest yet as widening economic divergences within the euro area strain the bank’s one-size-fits all monetary policy.
With the sovereign debt crisis threatening to engulf Portugal and bond yields in debt-strapped nations near euro-era highs, Trichet must decide when to stop buying government assets, withdraw unlimited liquidity provision for banks and possibly even raise interest rates to stem inflation risks. His response to those challenges may shape his legacy by helping to determine the euro’s future.
“2011 could be another annus horribilis for the ECB,” said Ken Wattret, chief euro-area economist at BNP Paribas in London. “Stress in debt markets hasn’t diminished and the divergence between euro-area countries is getting bigger. It’ll be a big challenge for the ECB and a tough job for its president to negotiate an appropriate path for monetary policy.”
Trichet, who chairs an ECB policy meeting today, has been forced to take unprecedented steps to buy time for the euro as governments struggle to agree on how best to shore up confidence in the monetary union. The decision to buy government bonds split the ECB’s Governing Council, and some policy makers have warned that price stability, the bank’s primary goal, could be compromised if emergency measures are left in place too long.
Inflation quickened to 2.2 percent last month, breaching the ECB’s 2 percent limit. The ECB’s 23-member council will nevertheless keep its benchmark interest rate at a record low of 1 percent today, according to all 53 economists in a Bloomberg News survey.
The decision is due at 1:45 p.m. in Frankfurt and Trichet holds a press conference 45 minutes later. The Bank of England kept its key rate at 0.5 percent today.
Euro-area economies are diverging as the debt crisis damps growth in peripheral countries while northern European nations such as Germany power ahead.
Portugal may join Greece and Ireland in receiving European Union aid as part of a package of new measures being discussed by governments to quell the crisis, according to four people with direct knowledge of the talks.
Spanish 10-year bond yields decreased nine basis points to 5.34 percent as of 12:15 p.m. in Frankfurt after investor demand in a five-year debt auction increased from November. Spain will pay an average yield of 4.542 percent on the new securities, up from 3.576 percent.
Italian borrowing costs increased to 3.67 percent at a sale of five-year securities today from 3.24 percent the last time they were sold on Nov. 12.
The German economy grew 3.6 percent last year, the most in two decades, the country’s statistics office said yesterday. By contrast, the Greek, Irish and Spanish economies shrank, according to European Commission estimates. Portugal’s is forecast to contract this year.
That’s making it harder for the ECB to determine when to exit from its emergency measures, and to set its “one-size- fits-all” monetary policy.
While the ECB describes its bond purchases and liquidity injections as “temporary,” it has repeatedly been forced to delay their withdrawal as the crisis intensified. Last month it said it will keep liquidity measures in place through the first quarter.
Continuing to pump cheap cash into the banking system risks fueling inflation in the longer term, yet withdrawing the measures too soon could frighten markets and push up the interest rates stricken nations have to pay on their debt, exacerbating the crisis.
By the same token, if the ECB keeps its key interest rate at a record low for too long as it tries to support struggling economies, it may stimulate too much growth in Germany and drive up prices there.
German inflation unexpectedly accelerated to 1.9 percent last month, pushing the euro-area rate above the ECB’s 2 percent limit for the first time in more than two years.
“The inflation outlook has worsened considerably,” said Klaus Baader, co-chief euro-region economist at Societe Generale in London. “If the inflation rate overshoots 2 percent for a few months that’s not a problem, but the question arises whether inflation expectations will remain anchored.”
The ECB will raise its benchmark rate in the fourth quarter of this year, according to a Bloomberg survey of economists. It would be the first policy tightening in more than three years and Trichet, whose term ends on Oct. 31, may leave the task to his successor.
Political jockeying for the job started more than a year ago, when heads of government chose Vitor Constancio of Portugal to be the ECB’s new vice president. It may enter another round when governments decide on a replacement for Austria’s ECB Executive Board member Gertrude Tumpel-Gugerell, whose term expires in May.
The next ECB president “will have to be someone who carries some serious weight, but also some diplomatic skills,” said Elga Bartsch, chief European economist at Morgan Stanley in London. “This combination is a rather rare one.”
Bundesbank President Axel Weber, a leading contender to take over from Trichet, has broken ranks with his ECB colleagues and annoyed some politicians by opposing the bank’s bond purchases.
Italy “would be honored” if its central bank governor, Mario Draghi, became the next ECB president, Prime Minister Silvio Berlusconi said in Berlin yesterday during a joint press conference with German Chancellor Angela Merkel.
Luxembourg’s Jean-Claude Juncker, who heads the group of euro-area finance ministers, said on Jan. 4 that EU leaders may not take a decision on Trichet’s successor until October.
For his part, Trichet has warned governments not to rely on the ECB to solve the debt crisis and urged them to take greater responsibility for fiscal imbalances. The bank’s policies “cannot substitute for government irresponsibility,” he said last week.
“Each year has thrown up a new set of acute challenges and this one isn’t going to be an easy one for Trichet either,” said Julian Callow, chief European economist at Barclays Capital in London. “Until his last day in office he’ll be trying to shepherd the euro area into calmer waters.”
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