The European Central Bank held interest rates at a record low today as renewed financial-market tensions complicate its exit from crisis mode.
The ECB’s Governing Council meeting in Frankfurt set the benchmark lending rate at 1pc for an 18th month, as predicted by a Bloomberg survey.
Near-record borrowing costs for nations across the euro region’s periphery are making it harder for the ECB to wean commercial banks off the cheap cash it provided to fight the financial crisis.
At the same time, slowing global growth is prompting the world’s other major central banks to consider further measures to prop up their economies.
The ECB “judges that easing policy too aggressively could create financial imbalances in the future,” said Nick Kounis, an economist at ABN Amro in Amsterdam.
“Stability is the name of the game in Frankfurt and this means a steady-hand policy.”
The Bank of England today left its key rate at 0.5pc and maintained its asset-purchase program at £200bn.
The Bank of Japan this week dropped its interest rate to “virtually zero” and expanded its asset-purchase program, while the Federal Reserve has indicated it may do more to stimulate growth.
The ECB meets after a month in which tensions in European credit markets intensified.
Irish 10-year bond yields soared to a record versus German bunds on September 29 on concern the bailouts of Anglo Irish Bank and AIB would overwhelm government finances.
The Portuguese-German 10-year yield spread, which hit a record on September 28, was at 400 basis points today, up from 88 basis points on March 10.
Rising sovereign borrowing costs are “having a knock-on effect on their banks’ ability to roll their short-term financing at interest rates that make economic sense,” said James Nixon, co-chief European economist at Societe Generale SA in London.
That’s “leaving the banks in these countries heavily dependent on ECB financing,” he said.
The ECB’s response to the financial crisis was to lend banks as much cash as they needed at its benchmark rate for as long as 12 months.
While it has phased out its 12- and 6-month loans, the central bank still lends unlimited amounts in its weekly, monthly and three-month tenders.
In May, it was forced to reintroduce the unlimited three-month loans and start buying government bonds as Europe’s deepening debt crisis started to threaten the survival of the euro.
Now policy makers are voicing concern that some banks’ reliance on the funds may prevent the ECB from exiting its emergency measures when it sees fit.
“These banks should be addressed by national authorities, otherwise we would have so-called zombie banks for some time,” ECB council member Mario Draghi said on October 1. The ECB must be free “from the constraint” of such dependency on its funding before it can implement an exit strategy, he said.
Some policy makers are growing impatient and want to press ahead with the exit. The ECB is “in the process of phasing out the non-standard measures” and loans maturing in the fourth quarter “won’t be renewed,” Executive Board member Juergen Stark said last week.
With the ECB unlikely to match other nations’ “expansive monetary policy measures,” the euro may continue to strengthen, crimping the region’s exports and economic expansion, economists at WestLB AG said in a research note.
Trichet may be pressed by reporters on the single currency, which has gained 17pc against the dollar in the past four months and touched $1.3994 today, an eight-month high.
“It’s a bit odd that the ECB seems to be in tightening mode when all other central banks are mulling more stimulus for their economies,” said Christoph Rieger, head of interest-rate strategy at Commerzbank in Frankfurt.
The International Monetary Fund said yesterday that the ECB should leave its emergency support for the region’s banking system in place and keep rates “exceptionally low.”
“Many banks remain highly dependent on ECB financing facilities” and moving away from unlimited lending “would be risky,” the Washington-based fund said in its World Economic Outlook.
The ECB won’t start raising borrowing costs until the fourth quarter of 2011, a Bloomberg survey of economists shows.