ECB holds rate at 1.5% at Trichet's final meeting

The European Central Bank (ECB) resisted calls to cut interest rates at President Jean-Claude Trichet’s final policy meeting on Thursday and may opt to use other tools to stem the sovereign debt crisis.

ECB officials meeting in Berlin left the benchmark rate at 1.5 per cent, as predicted by 41 of 52 economists in a Bloomberg News survey. Five forecast a cut to 1.25 per cent and six expected a reduction to 1 per cent. With Greece on the brink of default, the ECB is under pressure to step up efforts to stop contagion by shoring up the euro region’s bond markets and helping banks weather the storm.

“The earliest the ECB would cut rates would be in December, when it has new economic projections,” Tobias Blattner, a former ECB economist now working for Daiwa International in London, said before the decision. “The ECB needs hold back some firepower and at this meeting will focus on helping the banking sector with extra liquidity.” It has fallen to Trichet to lead the battle against the crisis as lawmakers squabble over their response. His push to resume government bond purchases in August split the ECB’s 23-member Governing Council and led to the resignation of chief economist Juergen Stark.

With Trichet’s eight-year term coming to an end on October 31, his final decisions in office may be among the most critical for the future of the euro — the currency he has championed as a symbol of European unity.

‘COLOSSAL DISASTER’
“Trichet holds Europe’s destiny in his hands at this point in time,” said Julian Callow, chief European economist at Barclays Capital in London, who expected a quarter-point rate cut on Thursday. “It would be a colossal disaster if we had a prolonged recession in the euro area. Policy makers have to throw the kitchen sink at it to prevent it.”

The Bank of England on Thursday unexpectedly expanded its bond- purchase program to £275 billion ($421 billion) from £200 billion after keeping its key rate at a record low of 0.5 per cent.

Trichet will hold a press conference in the afternoon. Economists said he may announce the reintroduction of 12-month loans to banks, a measure the ECB last used at the end of 2009. A discussion about reviving the ECB’s covered-bond purchase program to kick-start term funding markets was also on Thursday’s agenda, a euro-area central bank official told Bloomberg News on condition of anonymity.

ITALIAN DOWNGRADE
Trichet, 68, is stepping down just as Europe’s sovereign debt crisis spills into the financial sector after governments failed to prevent contagion from Greece to the euro area’s core. Market borrowing costs in Italy and Spain, the region’s third and fourth-largest economies, have jumped as investors fret about their public finances.

Moody’s Investors Service on Tuesday cut Italy’s credit rating for the first time in almost two decades on concern its economic growth may be too weak to enable the reduction of the region’s second-largest debt load.

While Trichet has stepped into the breach with ECB bond purchases, he may baulk at some of the proposals governments are considering to beef up their rescue fund, the European Financial Stability Facility.

‘NOT IN FAVOR’
One idea is to grant the EFSF a banking license so that it can borrow from the ECB to fund purchases of government bonds. Bundesbank President Jens Weidmann has said that would amount to printing money to fund distressed euro-area nations, and uTrichet told lawmakers in Brussels on Tuesday that he’s “not in favor” of the plan.

Andrew Bosomworth, executive vice-president and senior portfolio manager at Pacific Investment Management Company in Munich, said the ECB should drop its resistance to a Greek debt restructuring. Trichet has insisted that any private-sector involvement in a restructuring must be voluntary.

“By failing to cleanse the banking system of unrealised losses, the ECB is leading Europe down the same path as Japan’s lost decade of growth,” Bosomworth said.

Growth slowed to 0.2 per cent in the second quarter from 0.8 per cent in the first. The ECB last month cut its growth forecasts to 1.6 per cent from 1.9 per cent for 2011 and to 1.3 per cent from 1.7 per cent for 2012.

At the same time, inflation in the 17-nation euro region unexpectedly accelerated to three per cent in September, the fastest pace in three years and well above the ECB’s two per cent limit.

Trichet told European parliamentarians on Tuesday it’s “sometimes forgotten” that the bank’s primary objective is to “maintain price stability.”