ECB may keep stimulus in place next year too

European Central Bank policy makers signaled they intend to leave emergency lending measures in place into next year to support an economic recovery.

“When the economy is walking solely with the aid of fiscal and monetary crutches, it’s not advisable to whip them away,” Bundesbank President and ECB council member Axel Weber said today in Ploen, Germany. Luxembourg’s ECB council member, Yves Mersch, said the bank will monitor the impact of its stimulus measures “until the end of the year.”

The Frankfurt-based ECB is flooding banks with cheap cash in the hope they will lend it on to companies and households and get them spending again. While Europe is showing signs of emerging from its worst recession since World War II, policy makers are concerned the recovery will falter if the extra liquidity is removed too soon.

 

The fact that the economy of the 16 euro nations may return to growth in the current quarter doesn’t mean it’s time to withdraw policy stimulus, Finnish ECB council member Erkki Liikanen said yesterday. “We have slow growth in the euro area, much unused industrial capacity, and we have no inflationary pressures,” he said in Helsinki.

The ECB is lending banks as much money as they want for up to 12 months at its benchmark lending rate, which has been cut to a record low of 1 percent. The bank said in its monthly bulletin today that the loans “should promote the extension of credit” in the economy and “underpin its recovery,” which is likely to be “rather uneven.”

Weber said stimulus should start to be withdrawn only “when we see clear evidence of a sustainable recovery.”

Rising Unemployment
Rising unemployment and the expiry of government stimulus packages may damp economic growth next year. The ECB last week forecast the economy will expand just 0.2 percent in 2010 after shrinking 4.1 percent this year. The bank expects inflation to average 0.4 percent in 2009 and 1.2 percent in 2010, well below its 2 percent target.

Policy makers have pledged to scale back their emergency measures when the economy strengthens so that the abundance of cash in the economy doesn’t stoke inflation.

As demand for additional liquidity wanes, the ECB may simply decide not to renew some of its emergency loans when they mature, thus reducing the amount of money in the banking system. The central bank won’t start to raise interest rates until the third quarter of next year, a Bloomberg survey of economists shows.

“When the economy starts growing and demand strengthens, we must act so that the liquidity is withdrawn,” Liikanen said. “Rate increases come in at some stage. But they are two different things and we must always be ready and know what measures are needed.”