Trichet rebukes Merkel as ECB and Bank stick to their policies

European Central Bank to take 'unconventional' steps
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The Independent Online

The Bank of England dropped a hint that it may extend its policy of quantitative easing, colloquially known as printing money, yesterday, though rates and the current policy are unchanged. In Frankfurt, the European Central Bank did confirm that it will also turn to "unconventional methods" to stimulate the beleaguered eurozone economy, though to a much more modest extent.

Delivering sharply downgraded growth forecasts of minus 4.5 per cent for this year and minus 0.7 per cent for 2010, the ECB's president, Jean-Claude Trichet, also revealed that during a telephone conversation with the German Chancellor, Angela Merkel, he had reasserted the ECB's "fierce independence". Mrs Merkel pointedly criticised the ECB's drift towards quantitative easing on Tuesday, as well as making undiplomatic remarks about the US Federal Reserve and the Bank of England; Mr Trichet implied he had rebuked her.

The ECB said that it would, as expected, purchase €60bn (£53bn) of covered bonds between next month and June 2010. However, economists noted that they would be "automatically sterilised" in the phrase used by M. Trichet, implying that the aim was not to see a direct increase in the money supply to push inflation back up, as the Bank and the Fed intend, but merely to ease credit conditions further.

Covered bonds are so called because they are covered or collateralised with high grade assets behind them, usually rated AAA, though they can be as low as BBB for the ECB scheme, according to M. Trichet. They are usually issued by banks and other bodies with exposure to the private or public sectors, and remain in the books of the issuing institution. They are thus much safer and closer to conventional mortgages than the mortgage-backed securities that have now turned toxic. The costs and benefits of the policy could be divided between the ECB's 16 member states.

M. Trichet refused to say whether the eurozone official interest rate of 1 per cent represents a floor.

Analysts agreed that, whatever the details of the policy, the €60bn committed so far – and over a comparatively long timeframe – would have a relatively small effect on the eurozone's economy, being 0.6 per cent of GDP. The Bank of England's unapologetic boost to the money supply will approach 10 per cent of GDP in a few months.

In a terse statement, the Bank gave away little, but it did say that "the scale of the programme will be kept under review", adding to speculation that the Governor, Mervyn King, may ask the Chancellor to revise upwards the £150bn limit, of which £125bn has been committed. Most observers expect interest rates be 0.5 per cent until next year.

Howard Archer at Global Insight commented: "The Bank is particularly concerned that economic activity could be hindered for some considerable time to come by the need for financial institutions, households and companies to adjust their balance sheets. Serious concerns persist about the tightness of credit conditions."

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