Cautious interbank lending, public debt on ECB agenda

Skittish markets will be watching the European Central Bank closely today as governors hold their monthly meeting against a backdrop of a falling euro and cautious interbank lending.

There is little doubt the Central Bank's record low interest rate of one per cent will remain unchanged.

But ECB president Jean-Claude Trichet will field thorny questions about how the bank plans to steer out of its biggest crisis ever and restore confidence in the single currency and its promise to foster greater European integration.

In particular, investors want details on the bank's surprise decision to buy debt issued by countries like Greece, Ireland and Portugal and on how long the controversial Securities Market Programme might last.

One high-profile ECB governor, German Axel Weber, is known to have opposed the action, and he has stressed publicly the purchases should not exceed "a tightly capped limit."

Strict controls over information on the ECB's actions may have undermined their effectiveness, some say.

"The lack of transparency in the ECB's bond purchase programs is providing fertile ground for rumours and conjectures," UniCredit chief economist Marco Annunziata warned.

Mr Trichet can point to some good news meanwhile, like strong economic results from Germany, progress by eurozone finance ministers on a huge finance backstop for weaker states and the approval of a 17th member, Estonia, next year.

But the euro's plunge in value by more than 20 per cent from late 2009 to about $1.19 and chronic financial market pressure on peripheral eurozone countries have overshadowed plans to unwind unorthodox monetary measures.

Beyond the release of fresh eurozone growth and inflation forecasts by ECB staff, the bank might decide to keep providing unlimited amounts of money to commercial banks in a bid to prevent interbank markets from freezing up.

"The ECB may be left supporting the peripheral economy banking sectors longer than anticipated," Deutsche Bank analyst Mark Wall noted.

Banks have begun to draw heavily again on ECB lending facilities, even while this week placing a record of more than €361 billion in the central bank's overnight deposit facility, preferring safety over higher returns on interbank markets.

The ECB thus finds itself stuck "in crisis management mode" according to Karsten Junius of DekaBank, and forced to tackle issues normally beyond its remit, causing some observers to worry it is becoming politicised.

For now however, eurozone leaders have stopped pressing the ECB for policies aimed at adjusting the euro's value against other major currencies.

Politicians are generally happy the single currency's lower level against the dollar is boosting exports, but maybe less so when comments such as those from Hungary last week incite foreign exchange traders to rush for so-called safe havens like the Swiss franc.

Statements by members of the new government in Budapest that the country could face a debt crisis similar to Greece's demonstrated how negative market sentiment against the euro has become, since Hungary is not even a eurozone member.

"The ECB might be growing somewhat uncomfortable with the volatility of the euro (as opposed to its level)," RBS economists said in a research note.