Europe's central bank

THE European Central Bank (ECB) kept its main interest rate at 1% following its meeting on January 11th. Speaking after the decision, the bank’s president, Mario Draghi, was cautious in his assessment of the economy. There were tentative signs of stabilisation in activity but only at weak levels and the downside risks to the economy from financial-market tensions remained “substantial”, he said. The latest money-supply figures, though weak, do not suggest that there is a credit crunch. But such problems can take a while to emerge so credit supply will need to be monitored.  

Mr Draghi was more positive about the effects of ECB’s long-term refinancing operation (LTRO), carried out on December 21st, at which commercial banks were able to borrow €498 billion for three years at a low interest rate. The scheme had been effective, said Mr Draghi. Some markets for unsecured bank lending had reopened. The banks that bid hardest for the three-year ECB loans were often those that had debts maturing in the present quarter, when some €200 of bank bonds are falling due. The operation may thus have prevented a bank-funding crisis.

What is more, there are signs that the borrowed money is flowing around the economy. The ECB’s balance-sheet shows a big rise in deposits held by commercial banks as excess reserves alongside the increase in ECB lending to banks. But Mr Draghi cautioned against a judgment that banks had borrowed money only to hoard it. The more liquidity the ECB provides, the larger the liabilities side of the ECB’s balance-sheet (which includes deposits) must become. By and large the banks that have borrowed from ECB are not the same as those depositing with it, he said. This suggests that much of the borrowed money had first washed through the financial system before being parked at the ECB.  

The flood of liquidity may have helped lower government borrowing costs. Yields on long-dated bonds for Italy and Spain fell sharply today, after successful auctions of bond and bills in both countries. But there was yet not enough evidence to link the fall in long-term rates to buying by banks flush with ECB cash, said Mr Draghi.   

Mr Draghi did nothing to suggest that the ECB is ready to cut interest rates again in February. Monetary policy is already accommodative, he said, but the ECB would respond to worsening conditions. The vote to keep rates steady was unanimous, in contrast to the one on the cut in December. One of the likelier dissenters, Germany’s Jürgen Stark, has departed to be replaced on the bank’s executive board by Jörg Asmussen, previously Germany’s deputy finance minister. The other new face around the table was Benoît Coeuré, formerly a senior official at the French Treasury. Their arrival has not obviously shifted the ECB’s stance towards greater activism. But after a hyper-active meeting in December (when rates were cut and the three-year LTRO was announced) that was not a huge surprise.