ECB Falls Back on to Refinancing Operation to Boost Lagging Eurozone Recovery

By Jason Simpkins
Managing Editor
Money Morning

The European Central Bank (ECB) today (Tuesday) opened bidding for its first 12-month refinancing operation, hoping to boost liquidity in the eurozone where an economic recovery is struggling to stay on track.

The ECB announced last month it would double the maximum length of time it lends money to a year from six months. Demand for ECB funds is expected to be strong because few borrowers believe the central bank will lower interest rates - which are already at an all-time low 1% -- any further.

Results of the one-year refinancing operation will be published by the ECB tomorrow. Analysts anticipate the demand for the emergency liquidity will exceed the record $483 billion (348.6 billion euros) the ECB injected in a single operation in December 2007.

"This could be a big final easing - by stealth," Erik Nielsen, European economist at Goldman Sachs Group Inc. (NYSE: GS), told the Financial Times. "If I were a bank I would be gathering up all the furniture to use as collateral to take part."

The ECB announced its plans to extend its refinancing operation last month at the same time it made the decision to lower its main interest rate by a quarter percentage point to 1%.

ECB President Jean-Claude Trichet noted at the time that the first quarter had been "very bad" for the eurozone. The economy of the 16-nation eurozone contracted by 2.5% in the first quarter after shrinking 1.8% in the final three months of 2008. 

Concerned with the value of the euro, the ECB elected not to pursue policies of monetary easing as aggressively as Federal Reserve, its U.S. counterpart. 

Other central banks "have their own responsibility and decisions and I have already said that as far as we are concerned, we would be very, very keen to avoid to be put in a situation which for us would not be appropriate, namely a liquidity trap," Trichet said in January.

But Trichet's reluctance is partly to blame for Europe's lagging recovery. 

The preliminary Markit purchasing managers index (PMI), a closely watched survey released earlier today, showed that eurozone output fell for the thirteenth consecutive month in June.
The PMI rose to 44.4 in June, up from 44.0 in May. A reading of less than 50 indicates a contraction in activity, while a figure of more than 50 signals expansion. Economists had forecast a rise to 45.5, according to

Dominic Bryant at BNP Paribas told The FT that Europe's economy won't be gaining traction "anytime soon," and he expects the economy to be "more or less flat for the next four quarters."

Europe's underperformance when compared with the United States and United Kingdom will reflect "the less aggressive action of policy makers in the eurozone in the areas of monetary policy, fiscal policy and banking sector support," Bryant said.

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