Are you sure?

ECB policymakers warm to buying private debt

  The European Central Bank could start buying corporate bonds in an unorthodox measure to support the euro zone economy further, policymakers said on Thursday.

Vice-President Lucas Papademos pointed to buying private sector debt as an option to ease tensions in the banking sector, although he stressed no decision had yet been taken.

“It may be warranted that (the) central bank purchases private sector bonds to enhance liquidity,” he told a conference in Brussels. “This is a possibility, it has to be kept in mind. No decision has been taken, but it is a possibility that could improve the markets.”

Lending banks funds for longer in the ECB’s liquidity operations was another option, Papademos said. This backed comments by other ECB policymakers who have also flagged extending loan terms past the current maximum of six months.

Analysts said the comments raised the odds of the ECB narrowing the policy gap to other major central banks and starting direct asset purchases. This is slated for discussion at the ECB’s April 2 meeting, the same day that Group of 20 leaders meet in London to discuss a coordinated crisis response.

“Today’s comments from ECB Vice President look to us as the clearest admission to date that the ECB is getting closer to embarking on a purchase program,” RBS economists Jacques Cailloux and Silvio Peruzzo said.

Other analysts said a further slowing in private sector loans showed the ECB’s approach of offering banks all the funds they need in liquidity operations was not succeeding in getting funds to the real economy, and more action was needed.

ECB figures showed business lending dipped again in February after a rebound the month before, dragging annual growth to its lowest level since October 2005, and growth in household borrowing almost ground to a halt.

The weak loan data also backed bets that the ECB will cut its main policy rate by half a percentage point next week to a new record low of 1% and cut the overnight deposit rate, now acting as a floor for markets, to 0.25%.

ECB Governing Council member Nout Wellink said if interest rates reach a floor of almost zero percent, the ECB could take steps similar to the US Federal Reserve’s purchases of commercial paper and asset-backed securities.

“It cannot be ruled out that, if there is reason to do so, the ECB will take steps in that direction. Its statutes of association do not conflict with this,” he said in the annual report of the Dutch central bank, which he heads.


Papademos said the ECB was likely to stay focused on the banking sector in seeking alternative ways to boost the economy. The Bank of England and the US Federal Reserve have started buying government bonds under quantitative easing policies, but Papademos gave no sign this was likely in the euro zone.

“In the euro area, because the banking system has a more dominant role in the financing of the private sector than the capital market, compared with other economies, the implementation of such measures would be more focused on the banking system,” he said.

Analysts said the ECB would likely announce extensions to liquidity terms at next week’s meeting and eventually move to buy private debt, perhaps starting with bonds issued by banks. “The ECB is raising the stakes and seems now ready to face the crisis more aggressively than in the past,” said UniCredit Group economist Aurelio Maccario said.

“Perhaps hawks will (insist) that rates won’t go lower than 1%, but doves will feel reassured that the ECB will try to resemble the Fed and the BoE the most they can, given the institutional, legislative, and political hurdles.”

Policymakers have pointed to a number of practical problems that the ECB, which sets policy for 16 nations, would face in buying debt. Other leading central banks which are responsible for only one nation have fewer hurdles to overcome.

Papademos raised concerns about a “vicious circle” of negative effects between the real economy and the financial sector, and said inflation could turn briefly negative.

Wellink said the risk of global deflation was increasing mostly due to falling commodity prices, and he did not rule out months of falling consumer prices.

“On its own this is not a problem as long as consumers do not start to continuously postpone their purchases, waiting for further price falls,” he said. Fear of deflation was a key factor for US authorities to reduce interest rates close to zero and announce a big stimulus plan last month, Wellink said.

Meanwhile, the global economic recovery may take until 2011. “The consensus is that the economy will restart again somewhere in 2010. This consensus is not unrealistic,” he told a news conference. But it was impossible to predict the exact timing. “It could take two to three years before there will be recovery. Then we are in 2011,” Wellink said.

Wellink was quoted as saying later that he was disappointed by the European Commission’s proposed financial supervision reforms, because it did not include how European states should share costs when an international bank gets into trouble.

“It’s a deadly sin that the Commission is not making proposals on this. That limits the possibilities to give European institutions final powers,” Wellink was quoted as saying on the Web site of Dutch daily Het Financieele Dagblad. (Reuters)