Draghi drags his feet

Europe's central bank

  by J.O. | LONDON

THE European Central Bank will be an enthusiastic lender-of-last-resort to banks but not to governments. That was the main message from the bank’s president, Mario Draghi, after its monthly policy meeting on December 8^th.  The ECB voted to lower its benchmark interest rate from 1.25% to 1%, the second quarter-point cut in as many months. It also agreed on radical steps to help commercial banks secure the financing that private investors are increasingly loth to offer. But Mr Draghi scotched the idea that the ECB would step up its purchases of bonds of troubled euro-zone countries if a credible fiscal compact were agreed at the EU summit on December 9th.


Anything that smacks of direct monetary financing of governments—including “tricks” such as lending via the IMF—would go against the EU Treaty, said Mr Draghi at the press conference that followed the meeting of the ECB’s policymakers. Soon after his comments, stockmarkets around the world slumped, and the euro fell, as investors judged the ECB was unwilling to help fix the euro-zone’s government bond markets.
The ECB’s qualms do not, however, extend to helping commercial banks secure long-term lending on easy terms. European banks rely on wholesale funds to bridge the shortfall between deposits and loans. Investors willing to buy long-term bank bonds are growing scarce, which in turn makes banks loath to lend to businesses and consumers. To address this funding shortage, the ECB announced that banks will soon be able to borrow at its main interest rate for up to 36 months, with an option to pay back funds after a year. To further increase access to liquidity, the central bank said it will accept higher-risk asset-backed bonds, as well as bank loans, as security for its cash. The ECB will also cut the cash reserves that it requires banks to hold with it from 2% to 1% of assets.
Mr Draghi acknowledged that the outlook had darkened. The forecast by the bank’s economics staff is that GDP growth in the euro area will be in a range of -0.4% to 1% (a mid-point of 0.3%) next year, a far gloomier view than at the time of the previous forecast in September. Even so, not every member of the ECB’s 23-strong governing council was signed up to the bank’s quarter-point rate cut. The division was not one of substance but of timing, insisted Mr Draghi. Perhaps some members are still nervous about reducing interest rates as long as the euro-zone inflation remains above 2%, the level the ECB regards as a medium-term ceiling.
This division is worrying. If the ECB is split on the straightforward case for an interest-rate cut, it can scarcely summon consensus on the more complex business of government-bond purchases. The ECB’s chief echoed Jens Weidmann, the head of German’s central bank, when he set out the legal obstacles to buying bonds. The spirit of the EU  Treaty’s prohibition of monetary financing should “always be in our minds”, said Mr Draghi. He thus seemed to rule out schemes whereby the ECB could indirectly lend to euro-zone governments via either the IMF or the EFSF, the euro-zone’s rescue fund. Yet without the ECB’s more willing participation, it is unlikely that the forthcoming EU summit can conjure up a solution that restores confidence.