ECB Sets Cruise Control, Pushes Banks to Drive Growth

By Simon Kennedy and Simone Meier

July 3 (Bloomberg) -- European Central Bank President Jean- Claude Trichet is urging the region’s banks to play their part in generating an economic recovery.

Trichet yesterday said financial institutions should pass onto the “real economy” the 442 billion euros ($619 billion) it granted them June 24 and said the ECB has no immediate plans to ramp up its response to the crisis. He spoke to reporters after keeping the ECB’s main rate at a record low of 1 percent.

“The ball was played back to the banking system,” said Carsten Brzeski, an economist at ING Groep NV in Brussels. “The ECB has now released the accelerator and switched to cruise control.”

The ECB has been pumping unlimited funds into the financial system since October and banks will get even more cash next week when it starts buying 60 billion euros of covered bonds. Banks are nevertheless still restricting lending and the risk for the Frankfurt-based ECB is that they either hoard the cash to repair damaged balance sheets or direct it to other assets.

The ECB is focusing its efforts on banks because they account for about 75 percent of company financing in the 16- nation euro region, more than in the U.S. where they provide about a third of funding.

Last week’s auction, the first that gave banks unlimited funds for a full 12 months, “justified our call to commercial banks to be up to their responsibility to ship to the real economy,” Trichet said yesterday at a press conference in Luxembourg.

More Losses

Even with the cash, banks are concerned they face more writedowns from the credit crisis, said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. The ECB last month said commercial banks may lose a further $283 billion by the end of next year and Deutsche Bank AG Chief Executive Officer Josef Ackermann said July 1 that the financial industry is “not out of the woods yet.”

Loans to households and companies grew at the slowest pace since at least 1991 in May, rising 1.8 percent on the year, the ECB said this week.

“There is a serious concern that banks are in no position to kick-start lending,” Peruzzo said. “Banks are seriously under stress.”

Marco Annunziata at UniCredit Group says financial institutions may also keep putting money in safer assets or just leave it at the ECB. The central bank said today banks deposited 288 billion euros with it overnight, the most since Jan. 14. The ECB currently pays 0.25 percent on deposits.

No Certainty

“There is clearly no certainty that the liquidity will be promptly passed on to the real economy,” said Annunziata, chief economist at UniCredit.

If banks don’t act, the ECB may be forced back into action as the worst recession since World War II drives unemployment higher and prices fall. Trichet yesterday declined to say it had stopped cutting rates. Bundesbank President Axel Weber said June 23 that “direct intervention in the capital markets” would be necessary should banks fail to provide credit.

“The ECB has scope to take additional action if it appears that banks are still not markedly stepping up their lending,” said Howard Archer, chief European economist at IHS Global Insight in London. “The ECB could bypass the commercial banks and take more direct measures.”

Cash

There are signs that banks are moving the cash around, although not necessarily into the economy. The Euro Overnight Index Average, the rate at which banks lend to each other overnight, tumbled to 0.36 percent on July 2 from 1.38 percent on June 24, the day the ECB allotted the one-year loans.

“If the banks start to feel that the business climate is improving, then they’ll have better confidence to lend,” said Julian Callow, chief European economist at Barclays Capital in London. “The overall economic climate is really the key.”

Reports this week showed that the economy is still mired in a slump even though the recession may be moderating. Unemployment reached its highest in a decade in May and consumer prices recorded their first annual decline on record in June.

ING Groep, the largest Dutch financial-services company, said July 1 it would eliminate a further 800 jobs and Air France-KLM Group said on June 19 that it expects to extend job cuts at the company.

For now, Trichet is reluctant to step up his policy response amid concerns that stimulus measures are already storing up inflation risks for the future. The ECB has cut its benchmark rate by 325 basis points since early October.

Economists at Goldman Sachs Group Inc. and Lloyds TSB Group Plc say the ECB is unlikely to signal any change before September, when its staff publishes new economic forecasts.

The ECB probably wants “clear evidence” that banks are not lending before it implements more measures, said Jennifer McKeown, an economist at Capital Economics Ltd. in London. “The risk is that it waits too long, raising the prospect of a prolonged period of deflation and extremely weak growth.”

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net Simone Meier in Frankfurt at smeier@bloomberg.net;