Markets to focus on ECB credit measures this week

Agence France Presse

Posted at Aug 29 2010 02:11 PM | Updated as of Aug 29 2010 10:11 PM

FRANKFURT - Financial markets will be keen to hear this week if the European Central Bank plans changes to its exceptional measures to underpin lending amid mixed signals on the global economy.

The ECB's main interest rate will likely stay locked in at a record low of 1% Thursday as the central bank releases its latest forecasts for growth and inflation in the 16-nation bloc.

The bank "has absolutely no reason to raise interest rates," Capital Economics senior European economist Jennifer McKeown said.

Eurozone inflation stood at 1.7% in July, comfortably below the ECB's target of just under 2%, and should edge lower in August owing to cheaper energy costs compared with a year ago.

The ECB's headline interest rate is identical to that of the Bank of Japan, while the Bank of England's benchmark rate is 0.50% and the US Federal Reserve has kept its Fed funds rate at virtually zero.

Back in the eurozone, although Germany saw record growth in the second quarter and the region as a whole did better than Japan or the United States, countries on the periphery seemed to be falling behind.

The Greek economy contracted further, Portuguese and Spanish recoveries remained timid and Ireland's downgraded sovereign credit rating reminded investors the battle against deficit and debt was not over.

"Debt fears are back in European government bond markets," Barclays Capital economist Thorsten Polleit said.

The price that peripheral countries must pay to borrow money has widened again compared with benchmark German bonds and a controversial ECB program to buy sovereign debt slipped back into low gear last week after coming almost to a halt.

Household credit conditions are improving however and consumer confidence is getting stronger as labour markets improve, but corporate lending remains tight and business activity lost a bit of momentum in August.

A eurozone purchasing managers' index (PMI), a survey of 4,500 companies compiled by the data and research group Markit, fell slightly from its level in July and economists say Europe will soon feel the effects of slowing economies elsewhere.

Against that uncertain backdrop, analysts expect the ECB to raise its current 2010 growth forecast of 1% but are divided with respect to what the bank's outlook for next year will be.

Attention will focus on exceptional measures taken by the ECB to underpin lending, and especially on whether president Jean-Claude Trichet speaks about extending unlimited longer-term loans to commercial banks into 2011.

German central bank chief Axel Weber, an influential ECB governing council member tipped as a possible successor to Trichet next year, has said the ECB would pursue relaxed monetary policies, and focus on changes early next year.

Coming from one of the council's most orthodox members, Weber's remarks were taken by financial markets to mean the ECB would make sure commercial banks had no trouble getting past a traditional crunch period at the end of the year.

"Weber appears to have learned an important lesson from the past: not to be blinded by good German data," ING senior economist Carsten Brzeski commented.

He said the ECB had made "probably one of the biggest policy mistakes" by raising rates in 2008 when faced with a similar situation of strong growth in Germany and weaker eurozone economies elsewhere.

With "the dependence on ECB funding of banks from countries at the eurozone periphery, an early exit from unconventional policy measures is still a tough proposition to put into practice" now, Brzeski added.