Sally blog

ECB rate unchanged, focus on crisis measures

LONDON – The European Central Bank kept its benchmark interest rate unchanged at 1 percent Thursday as markets awaited word on whether the bank will keep its special measures to flood banks with cash and step up purchases of government bonds to help contain Europe's debt crisis.

All eyes will be on ECB president Jean-Claude Trichet when he holds his monthly post-meeting press conference shortly.

Expectations are that the bank will increase its level of support, one sign of how quickly the debt crisis has sharpened worries that a financially weak member of the eurozone such as Portugal might join Greece and Ireland in needing a bailout — and, even more dangerous, that larger countries such as Spain might run into trouble as well.

More support would be a turnaround for the bank. After last month's policy meeting, Trichet gave every indication that the central bank was looking at calling time on several props for the financial system introduced since the crisis took hold in August 2007.

But since Trichet's last post-meeting press conference on Nov. 4, the markets have dealt the 16-country eurozone a series of blows that have once again called into question the future of the euro currency itself.

The market pressure grew more and more acute on Ireland, eventually forcing its embattled government to follow Greece and request a multibillion bailout from its partners in Europe and the International Monetary Fund.

The response to its euro67 billion ($89 billion) bailout has been lukewarm at best as investors fret about the possibility that other countries will get dragged into the bond market mire and find themselves unable to borrow in the money markets. Portugal is most people's candidate to be the next potential bailout recipient. Its borrowing rates have risen sharply in recent weeks, though a bond sale on Wednesday went better than expected, easing some immediate pressure on the country's markets.

The real fear in the markets is that larger countries like Spain could become destabilized.

Most analysts think European authorities can handle bailing out the relative minnows of Greece, Ireland and Portugal, but Spain — at around 12 percent of the euro-zone economy — would be different matter altogether.

The hope, at least among those who think that the markets are currently massively overreacting by selling off government bonds, is that the ECB can instill some confidence, or at least some sense of balance. The ECB effort to buy bonds would support prices, and drive down yields — the borrowing costs that governments would face next time they tap the bond market to roll over their debt loads. Excessive yields can effectively cut off a country from borrowing, leaving it staring default in the face unless it gets a bailout.

"The hope would be that the ECB will fill the role of air-traffic controller, talking the market down to a soft landing," said Daragh Maher, an analyst at Credit Agricole.

As a result, there are expectations that the ECB will refrain from discontinuing special liquidity measures for banks and may actually announce additional liquidity support over a longer period.

Specifically, markets will be looking to see if the ECB will act even more boldly and indicate that it will step up its purchases of government bonds begun in May under its Securities Markets Program to at least stop bond prices from falling and yields from rising. So far, it has splashed out around euro65 billion in direct bond purchases.

Though the ECB may announce its broad intention, few analysts think it will be as explicit as the Federal Reserve, which last month announced its second major foray into the bond markets. It revealed that it was spending o$600 billion over eight months in an attempt to get market yields down.