ECB looks to help banks but rate cut unlikely

By David Mchugh

Associated Press

Published: Wednesday, Oct. 5 2011 11:20 p.m. MDT

BERLIN — The European Central Bank is likely to help banks with new credit but is not expected to cut interest rates Thursday, when Jean-Claude Trichet chairs his last monthly news conference before stepping down as president.

Tensions in financial markets have heightened this week on concerns that some banks will take heavy losses on government bonds from countries like Greece. The uncertainty means banks lend less to each other for fear of not getting paid back. That could hurt the real economy by limiting the flow of loans to businesses and households, as happened in 2008.

Economists think that to avoid such a lending squeeze, the ECB's 23-member governing council could announce new credit offerings to banks, such as unlimited amounts of six-month or one-year loans.

Experts don't rule out an interest rate cut to stimulate growth, but consider it less likely as inflation is still uncomfortably high.

Trichet, who will be succeeded by Bank of Italy head Mario Draghi when his eight-year term expires at the end of the month, typically prepares markets ahead of time for a change in rates through public speeches. So far, he has not hinted at any such move.

But markets will be eager to hear of any new help for the financial sector, whose troubles threatened this week to claim a first victim, Dexia, a Franco-Belgian bank heavily exposed to Greek government bonds. The French finance ministry said Wednesday it would offer a "solid, structured solution" on Thursday for Dexia, whose shares plunged this week.

In Germany, Deutsche Bank said Tuesday it would take €250 million ($333 million) in additional writedowns on the Greek bonds it holds and scrapped its profit forecast.

Experts and investors are increasingly resigned to the view that Greece will eventually default on its debts.

The country faces bankruptcy if it does not get its next €8 billion installment of money under a 2010 bailout; the European Commission, International Monetary Fund and ECB say a decision won't come until the end of the month.

That delay leaves the ECB holding the line against the crisis through its purchases of Italian and Spanish government bonds. The purchases keep those countries' borrowing costs in the bond markets down, and avoid the fear-fueled spiral of higher rates that drove Greece, Ireland and Portugal to need bailouts.

Many economists expect the ECB will open its credit window wide for banks to borrow, as it did during the financial crisis that followed the 2008 collapse of U.S. investment bank Lehman Brothers.

It could also buy collateral-backed, low-risk securities known as covered bonds, improving access to an important funding source for banks.

In that case, analysts say the bank could buy directly from issuers, and its presence on the secondary market could help keep bank funding costs down. It made €60 billion in such purchases earlier in the crisis.

The ECB already regularly offers short term credit for as long as 3 months, but extending the loan period means banks are less vulnerable to market turmoil.

Most economists think the bank will leave its key interest rate at 1.5 percent, but will lower it to 1.0 percent by early next year.

Rate cuts stimulate growth, and there are signs the eurozone is headed for a recession. Slower growth will only make the debt load harder to pay back for some countries, and could mean fewer resources for creditor governments such as Germany and France to help them.

But September's unexpectedly higher inflation rate of 3.0 percent means the bank's rate-setting council is likely to wait, since lower rates can fuel inflation.

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