[BANKS] ON THE ECB'S "SAFETY VALVE"

Nice3 WSJ article on the problems faced by the ECB (*). The "safety valve" has worked, and a complete meltdown has been avoided. But credit is still not flowing to businesses in Southern Europe.

 

Mario Draghi has toiled to repair the euro zone’s broken financial engine, fueling banks with cheap loans and installing a safety valve through an openended bond-buying program. This has calmed financial markets. But the European Central Bank president still can’t seem to fix the transmission. Until that happens, further rate cuts or bank- support measures may have little effect. As it is, the ECB is expected to hold rates steady at 0.75% after Thursday’s monthly meeting.

 

A cut can’t be ruled out with inflation below the ECB’s 2% target, at 1.8%, and expected to fall more in coming months. Even if a cut occurs, though, it wouldn’t do much for countries in Southern Europe. In healthy economies such as Germany, lower ECB rates feed through the economy by spurring consumer borrowing and business financing for investment. Not so in Spain and Italy. Their economies are mired in deep recessions and unemployment is at euro- era records. Political uncertainty remains high, especially in Italy. There, risk- averse banks aren’t likely to cut rates for privatesector clients.

 

 

 

“If the ECB cuts interest rates, it does so to the benefit of Germany but not Italy, that’s the whole problem with the transmission mechanism,” said UniCredit’s Marco Valli. The ECB offered a grim reminder of this on Tuesday. Small businesses in Spain, Italy and Portugal paid much higher rates for loans in January than their German counterparts, according to a monthly report. Policy makers could try to narrow this gap. One option is to lower the discounts, or haircuts, that they apply to small- business loans posted by commercial banks as collateral for ECB funds.

That would encourage banks to extend more of these loans. But the ECB tinkered with collateral rules before with little effect. Relaxing them further may stir the rancor of the bank’s conservative wing, led by Germany’s Bundesbank. That leaves the ECB in a tight spot. Car registrations in Mr. Draghi’s native Italy plunged 17% in February from a year earlier. They were down 12% in France. Until the ECB’s top mechanic finds a way to juice the economy, European households aren’t likely to rev their own spending engines.

(*) Brian Blackstone: "ECB Mechaninc Gropes for Right Wrench", Wall Street Journal, 6 March 2013.

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(See also this WSJ editorial, 7 March 2013: "[Recent ECB steps have] helped prevent panic in the bond markets despite the unsettled Italian election result. But preventing disaster isn't the same as promoting growth. The monetary transmission mechanism, whereby ECB policy decisions influence the real economy, remains broken. In the euro area as a whole, household and company borrowing rates are about 1 to 1.2 percentage points higher than might be expected based on Euribor and sovereign-bond yields, based on JP Morgan, with particular problems in Italy, Spain, Portugal and the Netherlands.)
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