ECB pumps liquidity to aid banks but keeps interest rates on hold

Departing president Trichet warns of 'intensified downside risks' to eurozone economy

The European Central Bank will step up its support for struggling banks after deciding against lowering interest rates at what was Jean-Claude Trichet's last policy meeting before he stands down as president of the central bank later this month.

The ECB governing council held rates at 1.5 per cent when it gathered in Berlin yesterday, although Mr Trichet, speaking after the announcement, acknowledged the "particularly high uncertainty and intensified downside risks" colouring the economic outlook. "Ongoing tensions in financial markets and unfavourable effects on financing conditions are likely to dampen the pace of economic growth in the euro area in the second half of the year," he said.

The decision prompted criticism from Angel Gurria, the head of the Organisation for Economic Cooperation and Development, who said: "I would have gone for a cut in the rate if I had something to do with it, simply because I think our greatest concern now is growth."

The ECB did, however, step in to help European banks by announcing plans to resume lending money for around one year to those struggling to raise funds at benchmark rates.

The decision to lengthen the duration of funding from six months came as the European Commission said it was readying plans for co-ordinated action to strength lenders' capital buffers. Earlier, the European Banking Authority, which sets the parameters of banking stress tests, said it was reviewing lenders' capital positions.

Mr Trichet said the ECB would also resume purchases of covered bonds, which offer investors claims on mortgages and public sector loans, and are seen as among the safest of securities. The steps are aimed at boosting liquidity across the European banking system as nervousness mounts over exposures to debt issued by troubled countries on the continent's periphery.

The Franco-Belgian lender Dexia has been at the centre of such concerns in recent days. Yesterday, its shares were suspended as it talked to international investors about selling its Luxembourg arm. The bank is to hold a board meeting this weekend to discuss its options, including a rumoured break-up.

Although he increased support for the sector, Mr Trichet rejected the notion that the ECB could take part in leveraging the revamped European Financial Stability Facility – the eurozone's bailout fund – to give it more resources. "The governing council does not consider it would be appropriate," he said, adding that the matter was for national governments, who had the capacity to take such action.

On interest rates, he said the ECB governing council had had a "long discussion on the pros and cons" but had "decided by consensus to maintain rates". Economists said his comments indicated that rates may ease after his successor, the Italian central banker Mario Draghi, takes over.

RBC Capital Markets' senior economist, James Ashley, said: "Policy is no longer described as 'accommodative', liquidity is no longer 'ample', and [the] decisions were reached 'by consensus' (rather than unanimously)... we think it is now only a matter of time before the consensus on the governing council swings in favour of reversing [rates] back down to 1 per cent."

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