By Simon Kennedy
Aug. 24 (Bloomberg) -- European Central Bank officials led by President Jean-Claude Trichet greeted mounting evidence of an economic recovery with caution, suggesting they won’t rush to reverse their emergency stimulus.
“We see some signs confirming that the real economy is starting to get out of the period of freefall,” Trichet said at the U.S. Federal Reserve’s annual symposium in Jackson Hole, Wyoming, on Aug. 22. This “does not mean at all that we do not have a very bumpy road ahead of us.”
The wariness indicates the ECB won’t soon rein in the steps it took to staunch the deepest slump since the 1930s, such as by charging banks a higher interest rate when it next lends them unlimited money for a year. While the economy may be expanding again after contracting 0.1 percent in the second quarter, it’s dependent on policy makers for support and is threatened by the highest unemployment rate in a decade and the weakest bank lending on record.
“Even with the pretty nice figures we’ve been seeing, some at the ECB question how sustainable the recovery is,” said Gilles Moec, a former Bank of France official and now an economist at Deutsche Bank AG in London. “The ECB is not yet looking to start ending their exceptional measures.”
Figures to be released this week may add to optimism a recovery is now under way, with economists predicting consumer and business confidence rose in the euro area this month to the highest since October. Industrial orders gained in June by the most in 19 months, data showed today.
Credit Contraction
European stocks rose last week, sending the Dow Jones Stoxx 600 Index to its highest level since October. The index, which is about 40 percent below where it was when the credit contraction began two years ago this month, was 0.7 percent higher on the day at 10:32 a.m. in London.
Ludwigshafen, Germany-based BASF SE, the world’s biggest chemical company, said on Aug. 20 that it now has fewer employees on shortened workweeks at its main German plant as demand is stabilizing. Munich-based Centrosolar Group AG, the maker of rooftop solar-energy systems, said the next day it aims to return to profit this half as demand from homeowners rises and it overcomes losses in Portugal and the Netherlands.
Such improvements don’t yet merit the ECB beginning to unwind its aid, Governing Council members Ewald Nowotny and Erkki Liikanen said in separate interviews at the Jackson Hole forum sponsored by the Kansas City Federal Reserve Bank. Trichet and about half his 22-member council attended the conference.
‘Steady Hand’
“There is no reason to reassess our monetary-policy stance,” said Liikanen, who runs the Bank of Finland. Nowotny, the head of Austria’s central bank, said he didn’t see “any need for immediate reaction” and that officials would maintain “a policy of steady hand, but without pre-committing.”
“The freefall is over, but we must remember the level of economic activity is still below what it was a year ago,” said Liikanen. Bundesbank President Axel Weber told CNBC that it’s “too early to say it won’t be a bumpy road ahead.”
When needed, the ECB will implement a “credible exit strategy” from its crisis policies, Trichet said.
“The Governing Council will ensure that the measures taken are quickly unwound and the liquidity provided is absorbed once the macroeconomic environment improves,” he said.
Record Low
The Frankfurt-based ECB has fought the financial crisis and economic slowdown by cutting its benchmark interest rate to a record low of 1 percent and beginning a 60 billion-euro ($86 billion) program of buying assets.
In June, it lent banks a record 442 billion euros for 12 months and will again offer them the chance to borrow for that long in September. The ECB said on May 7 it may eventually demand higher interest than the benchmark for the funds so as to make them less attractive.
Trichet used a 20-page paper at the conference to defend his institution against criticism that it has been too cautious given its rate cuts and asset purchases have been slower and shallower than elsewhere.
The ECB is guided by its primary aim of delivering stable prices and is also focused on reviving bank lending, he said. It has succeeded in leaving “no discernible doubt” among investors that it will control inflation, while also easing the liquidity constraints at banks, Trichet said.
The bank’s decision to raise rates in July 2008 helped anchor inflation expectations, keeping inflation-adjusted interest rates lower in Europe than in the U.S. when deflation fears mounted later that year, he said.
‘Gradualist Approach’
“Criticizing a central bank that is acting with a steady hand for being ‘behind the curve’ rather misses the point,” Trichet said. “A gradualist approach of this kind may be the most effective antidote to the threat to price stability.”
Responding to a presentation, ECB Executive Board member Juergen Stark outlined reasons for keeping borrowing costs away from zero as the ECB has chosen to do. The lower rates go, the more markets risk being distorted, offsetting the stimulation of easier monetary policy and potentially fuelling future inflation and asset bubbles, he said.
Stark also told the gathering that there’s “no need” for the bank to alter its target of keeping inflation just below 2 percent. Trichet said he doubts whether central banks can better target asset-price gains in a “mechanical way.”
‘Sluggish Growth’
While declining to say whether the central bank will raise its economic outlook when it releases new forecasts on Sept. 3, Nowotny said he expected growth next year. The ECB said in June that the economy would contract by about 0.3 percent in 2010 after shrinking 4.6 percent this year.
“It will be a rather sluggish growth after a sharp decline,” Nowotny said. Liikanen, who also refused to comment on the estimates, said “everyone remains cautious” and unemployment will rise beyond the 9.4 percent rate reached in June.
Economists at Deutsche Bank and UBS AG are among those who last week forecast the economy will be healthier than they previously thought and brought forward their predictions for when the ECB will next raise rates to next year from 2011. Deutsche Bank now projects the economy to grow 1.3 percent next year and UBS is predicting 2.1 percent.
Trichet ended his speech with a demand for policy makers not to forget the lessons of the crisis and to maintain efforts to avoid a repetition.
“The largest mistake we could make would be to forget the importance and urgency of this task,” he said.
To contact the reporter on this story: Simon Kennedy in Jackson Hole at skennedy4@bloomberg.net
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