ECB Power Grows Beyond Borders as Neighbors Seek Aid

By Simon Kennedy

Oct. 16 (Bloomberg) -- The European Central Bank's power is growing beyond its borders as the financial crisis forces neighboring economies to seek its shelter.

Hungary today won a loan of up to 5 billion euros ($6.8 billion) from the ECB to help spur its local credit market, a day after Switzerland said it will conduct currency swaps with the Frankfurt-based central bank. Iceland, whose banks have collapsed, is also seeking greater support. None are among the 15 nations which use the euro.

ECB President Jean-Claude Trichet is strengthening his position as the continent's guardian of financial stability even after he was last week forced to reverse July's interest-rate increase. When the dust settles, the greater reliance on the ECB may result in some nations accelerating efforts to join the currency bloc.

``It looks like the ECB is coming through the crisis with an enhanced reputation and questions are being asked of other central banks as to whether they have the scale to handle these kind of problems,'' said James Nixon, an economist at Societe Generale SA in London and a former ECB forecaster.

Markets in some eastern European countries are being roiled after a boom following their entry to the European Union in 2004 as banks worldwide hoard cash and investors shun riskier assets. Stock indexes in Hungary, Poland and the Czech Republic have lost more than a fifth of their value in the past month on concern bursting real estate bubbles and slowing exports will push them into recession.

Hungary Support

As they find themselves lacking the tools to defend their markets and protect their economies, central banks outside the euro area are turning to the ECB for ammunition. Hungary today became the first eastern European economy to receive ECB support after some commercial banks suspended foreign currency loans and demand on the government bond market dried up.

``The ECB will be busy in central and eastern Europe in the coming days, weeks and months,'' said Lars Christensen, chief analyst at Danske Bank A/S in Copenhagen. ``It obviously wants to preserve financial stability.''


Hungary will use the loan to supply euros to local lenders through currency swap transactions, starting today.

Iceland too is looking for aid after its foreign-market froze and its three largest banks collapsed. Foreign Minister Ingibjorg Solrun Gisladottir wrote in the Morgunbladid newspaper on Oct. 13 that her country needs ECB assistance even though it's not in the 27-nation EU let alone the euro region.

Renewed Allure

In Switzerland, where the government today gave UBS AG a $59.2 billion rescue, the central bank is receiving ECB backup in the form of a seven-day currency swap. It has been unable to bring the three-month Swiss franc Libor rate within its target range since it cut that band to between 2 and 3 percent on Oct. 8.

The crisis ``shows that you need a strong central bank,'' said Stefan Bielmeier at Deutsche Bank AG in Frankfurt. ``The joint currency is certainly becoming more attractive in the current environment.''

Policy makers are already looking for the ECB to extend its powers more broadly than its mandate currently allows.

Hungarian Prime Minister Ferenc Gyurcsany said Oct. 14 that the EU should allow the ECB to intervene across the entire bloc rather than just the currency region. He said Hungary's forint should be placed in the exchange-rate mechanism, a system designed to test its stability before euro adoption, by a 2010 parliamentary election, the Financial Times reported.

U-Turn

Support for the ECB is mounting even after the credit crunch last week forced it to cut its benchmark rate to 3.75 percent having boosted it to 4.25 percent as recently as July. The ECB yesterday performed another U-turn in widening the type of collateral it accepts when lending to banks.

Some countries may nevertheless find it difficult to join the euro area as the financial crisis saps their ability to meet the ECB's entry requirements, said Neil Shearing, an economist at Capital Economics Ltd. in London.

Among the terms that govern entry to the euro region, a country must pare its budget deficit to below 3 percent of gross domestic product and its debt to below 60 percent. Hungary's government is aiming for a fiscal shortfall of 3.4 percent this year and debt is about 65 percent of GDP.

``It's going to be much more difficult to generate public and political support for the euro,'' said Shearing. After Slovakia joins Jan. 1 he doesn't expect another member before Poland in 2012 at the earliest.

`No Plans to Join'

Nor is support for euro membership growing in all European countries. British Prime Minister Gordon Brown today repeated his opposition to giving up the pound right away, saying ``we continue to review it but we've got no plans to join.''

For now, the ECB's new-found prominence is boosting the allure of euro membership even for some of the countries which once were skeptical of joining.

The leaders of Denmark and Sweden said this week that the financial crisis highlights the value of joining the currency bloc. Polish Prime Minister Donald Tusk had already surprised investors last month by saying his country will target 2012 for joining the euro.

``When it's a little unsafe out there it's better to be inside a big currency like the euro,'' Swedish Prime Minister Fredrik Reinfeldt said yesterday.

To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net