ECB At Loss on More Steps as Rates Fall to Record Low

By Jana Randow

Feb. 20 (Bloomberg) -- European Central Bank policy makers are at a loss for what additional steps to take as record low interest rates fail to stem the deepening recession.

Officials are hemmed in by European Union rules that forbid the ECB from buying bonds directly from governments and any decision to buy debt in the open market may spark a dispute over which country’s securities to purchase. Options are also limited by the lack of a single euro-region Treasury that would underwrite central bank losses incurred from any new measures.

“The problem is that they don’t know themselves what they’ll exactly have to do in the future,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London. “They are probably very divided on the range of measures available to them.”

The danger is that the ECB, led by President Jean-Claude Trichet, slips into paralysis just as the 16-nation euro region spirals deeper into recession and other central banks get permission from their governments to create money or buy securities.

“We exchange very different viewpoints” on the need for non-standard measures, Trichet said Feb. 5. Nine days later he said that “no decision has been taken yet.”

Governing Council member George Provopoulos said Feb. 16 the ECB hasn’t even discussed buying government bonds in the secondary market, which some economists say it may be entitled to do.

Alarming Policies

Purchases of national debt may suppress yields and help governments criticized by ECB board member Juergen Stark for running “alarming” budget policies.

At the same time, Finnish board member Erkki Liikanen says the ECB, hasn’t “exhausted” its creativity, without commenting on specifics.

The ECB’s silence on the concrete steps open to it is starting to spook investors as financial tensions in Europe worsen and is leading to calls for more clarity on the central bank’s thinking.

“We’re desperately spinning around to get a proper handle on the issue,” said Ken Wattret, senior economist at BNP Paribas SA in London. “The worst-case scenario is that the ECB is hoping they don’t need to do things like this because the economy will pick up again. If that’s plan A, then that’s rather disturbing.”

German Finance Minister Peer Steinbrueck this week became the first senior official to say a euro nation could run into fiscal difficulty. Bond spreads are also widening and the gap between Austrian and German yields swelled to a record yesterday on concern about Austria’s exposure to eastern European banks.

Zero Rates

As rates head towards zero around the world, the Federal Reserve and Bank of England are turning to their governments for help as they ramp up their response. The U.S. has issued special Treasury bills to help buttress the Fed’s balance sheet. The U.K. central bank has asked the Treasury for permission to start quantitative easing and increase the supply of money.

The problem for the ECB is that its room for maneuver is constrained by the euro’s governing rules. The Maastricht Treaty never created a Europe-wide finance ministry, a fact that Billionaire investor George Soros said Feb. 17 “must be confronted.”

The treaty forbids the ECB from bailing out any distressed nations and limits its scope to purchase securities in the market as part of a quantitative easing policy.

Left Alone

Buying bonds “might constitute as direct monetary finance of fiscal deficits, which isn’t allowed by the ECB’s rules,” said Greek central banker Provopoulos. The bank’s “position is that every country is responsible for resolving its own fiscal difficulties.”

Quantitative easing would be “much more complicated in the euro-zone context than some people might believe,” council member Yves Mersch told the Financial Times in an interview published Jan. 26. The ECB could buy government securities -- “but the bonds of which country?” -- the FT cited him as saying.

Purchases might help nations such as Ireland, Spain and Greece just as the European Commission urges them to get their budgets back in line. Stark said Feb. 11 that the “fiscal situation in some country is alarming.” The spread between the yields on Spanish and Greek debt and 10-year German bunds this week ballooned to the most since before they joined the euro.

Out of Room

“They have much more issues to address than the Fed or the BOE,” said Aurelio Maccario, chief euro-area economist at UniCredit Group in Milan. “Probably they would want to be more transparent but there’s much discussion going on and they really can’t.”

The ECB is running out of room to help the economy with standard rate policy. While the central bank has cut its benchmark rate four times to 2 percent since early October, the International Monetary Fund forecasts the economy will contract 2 percent this year, the worst on record for the currency union.

For now, some economists say they’d like more insight into the ECB’s thinking, even if officials haven’t made up their minds yet. Analysts expect the ECB to cut the benchmark rate to 1.5 percent next month, the lowest in the euro region’s 10-year history and just half a point above the Bank of England’s rate.

“It would be better to know what they’re discussing than only to know that they argue intensively,” said Michels.

To contact the reporter on this story: Jana Randow in Frankfurt jrandow@bloomberg.net.