ECB Piles Pressure on Governments

by Richard Barley

Wall Street Journal
December 8, 2011

What the European Central Bank giveth with one hand, it taketh away with the other. President Mario Draghi has cut rates twice in two months and is pumping cash into the banking system in an attempt to stave off a credit crunch. But he poured cold water on hopes that the ECB would respond with massive support if euro-zone leaders manage to deliver a better fiscal framework. It remains to be seen if Mr. Draghi is bluffing, but the stakes couldn't be higher.

The ECB cut rates by 0.25 percentage point to 1%, and with its staff forecasting sharply lower growth and lower inflation, further cuts may follow. More significant was unprecedented support for banks. Mr. Draghi announced two three-year unlimited loans, the first to be granted Dec. 21. That should give some certainty to banks locked out of bond markets, and help prevent emergency asset sales. Banks will be able to submit a greater variety of collateral, including loans, which should give smaller institutions greater access to central bank funding. And the ECB cut the reserve ratio applied to deposits to 1% from 2%; this should free up €103 billion of cash, according to Barclays Capital.

But these measures may simply lead to more liquidity sloshing around in European Central Bank deposit facilities. Without a solution to the euro-zone crisis, it is hard to see banks rushing to lend even if their financing is backstopped. Still, the ECB is clearly doing overtime as a lender of last resort—if only to banks.

More