Euro central bank doesn't cut but clears the deck for lower interest rates at next meeting

10/06/2011 1:26 pm EST


Jim Jubak

Founder and Editor,

Disappointment that the European Central Bank didn’t cut its 1.5% benchmark interest rate at today’s meeting has given way to the realization that the moves the bank did make today clear the decks for a rate cut perhaps as early as the bank’s November 3 meeting.

It’s not like the European Central Bank did nothing today. Jean-Claude Trichet, fronting his last press conference as bank president, reported that the European Central Bank would extend the duration of its loans to banks from the current six months to a long as 13 months. And that the bank will continue to lend banks as much money as they need through its regular refinancing operations until at least July 2012. Not quite the U.S. Federal Reserve’s guarantee to keep rates at their current near 0% level until at least the middle of 2013, but still a big step that will give bank’s greater confidence in bank policy over the next nine months.

Just as important was what the bank didn’t do. Trichet acknowledged that inflation, which climbed to a 3% annual rate in September, is like to remain above the bank’s 2% limit for the rest of 2012. But inflation will fall in 2012, as European economies slow, he said. There was absolutely no indication that the bank was contemplating any move on inflation. That’s quite remarkable restraint for an institution that couldn’t wait to raise interest rates earlier this year.

Trichet also announced that the bank would buy $53 billion in covered bonds. This resumes a program that expired in June 2010. Covered bonds—bonds backed by mortgages or public-sector loans—are a major source of financing for Europe’s real estate sector. With the European Central Bank back in the market banks will be able to sell covered bonds from their portfolios and free up space, the central bank hopes, on their balance sheets for new real estate lending.

Of course, with banks facing pressure to raise their capital ratios, it’s more likely that banks will use this covered bond-buying program as an opportunity to shrink their own balance sheets (fewer loans on the books raises the capital ratio) instead of making new loans.

As of 11:345 a.m. New York time the German DAX Index was up 3.2%, the French CAC 40 was up 3.4%, and the Spanish IBEX was up 2.7%.

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