Trichet Engineers `Regime Change' at ECB as Europe Banks Totter

By John Fraher

Oct. 9 (Bloomberg) -- European Central Bank President Jean- Claude Trichet is opening up the floodgates as the credit crisis threatens to cripple the region's banking system.

Traditionally slower than its global counterparts to shift policy, the ECB yesterday cut interest rates for the first time in five years, joining in a global round of reductions. Trichet declined to rule out further steps and said he will offer banks unlimited cash to help them cope with frozen money markets.

``This is a regime change,'' said Robin Marshall, director of international fixed income at NCL Smith & Williamson, who oversees about $20 billion in assets. ``This is a significant day in which they've gotten real about the financial crisis.''

Trichet and other central banks are scrambling to restore confidence in the global financial system after the credit crunch spread from the U.S., pushing up borrowing costs to records. The need for action is especially acute in Europe after governments failed to agree on a rescue package acceptable across the region.

The ECB lowered its key lending rate by half a point to 3.75 percent, erasing a quarter-point increase in July, as the 15- nation euro region teeters on the brink of a recession. The bank also said it will start lending banks unlimited cash in its weekly auctions at the new benchmark.

Asked if the rate cut was a one-off, Trichet replied: ``I don't say that. I say that we will always do whatever is necessary.''


About Face

``We're all very struck by how the ECB has turned around so quickly here,'' said Julian Callow, chief European economist at Barclays Capital in London. ``This will go down as an historic day for the ECB.''

Commercial banks are refusing to lend to each other after the U.S. housing slump caused the collapse of New York-based Lehman Brothers Holdings Inc. That's pushed up market rates even as the ECB and other central banks injected billions of euros and dollars into the banking system.

With Trichet legally powerless to emulate the role of Federal Reserve Chairman Ben S. Bernanke as a point man for bank rescues and leaders bickering on a common approach, governments have been going it alone. Spain on Oct. 7 set up a rescue fund for banks, while Belgium, France and Germany have moved to rescue institutions such as Fortis, Dexia SA and Hypo Real Estate Holding AG.

Trichet is nevertheless doing what he can within his remit.

`Strongest Weapon'

The decision to lend banks as much as they want shows the ECB ``is now really deploying its strongest weapon to bring money-market rates down,'' said Stefan Bielmeier, an economist at Deutsche Bank AG in Frankfurt. ``This brings them closer to becoming a European clearing house.''

The ECB also narrowed the corridor around its key rate to 100 basis points from 200 points. That means it reduced the cost of emergency overnight cash to 4.25 percent from 4.75 percent and raised the rate it pays banks for overnight deposits to 3.25 percent from 2.75 percent.

Some economists are skeptical the measures will succeed.

``It's a step in the right direction, but on its own it won't solve the problem of trust and fear that's freezing money markets,'' said Marshall.

The U.S. Federal Reserve cut its benchmark rate by a half point to 1.5 percent. The central banks of the U.K., Canada, Sweden and Switzerland also reduced borrowing costs. China cut interest rates for the second time in three weeks.

Inflation Fears

The Fed has now cut its key rate by 3.75 percentage points since the credit crisis started in August 2007. The ECB was reluctant to follow suit because of its concern that faster inflation will trigger a wage-price spiral as workers seek compensation for the higher cost of living.

While inflation slowed to 3.6 percent in September from a 16-year high of 4 percent in July, it remains above the ECB's 2 percent limit. Germany's IG Metall labor union, representing 3.2 million workers, is seeking the biggest pay increase in 16 years.

Inflation concerns are nevertheless unlikely to hold the ECB back as the financial crisis worsens, said Mark Wall, a London- based economist at Deutsche Bank AG.

``I would not be surprised if there were one or two dissenters, but the central bankers closest to the crisis realized the depths to which we were going,'' said Wall. ``The ECB is going to be cutting rates further, maybe as far as 2 percent. We're in a fast-moving situation.''

To contact the reporter on this story: John Fraher in London at jfraher@bloomberg.net