ECB considers mess left by decade of greed

THERE has been an implicit assumption since the US subprime scandal broke last August and the Federal Reserve Bank started to cut interest rates, that the ECB had almost a moral obligation to take the lead from the US central bank by cutting rates immediately.

The fear was the global economy would be brought to its knees as banks stopped lending to each other.

The problem was many of them were exposed to the US mortgage-lending debacle and nobody knew the extent of the exposure for individual banks.

With that exposure running at more than €140 billion at the last count, and likely to run to €400bn, the nervousness among bankers about their fellow bankers was well justified.

While we have had a few collapses within the banking sector, most notably Northern Rock, the concerns in that regard are easing.

Had the ECB gone ahead at the time with a justified rise in rates, it would have damaged its own credibility because it would have made credit dearer at a time when the refusal of banks to deal with each other was hitting the cost of borrowing.

Full credit to the ECB for not acting on its basic instincts back in September.

The decision not to raise rates, however, raised expectations the bank was about to mimic the actions of the Fed by going on an interest-rate cutting spree.

Six months later the bank has stood firm and left its rates unchanged as it sees the threat of inflation as a bigger issue for the euro area than the threat of a global recession triggered by the subprime crisis in the US, which was not it its making.

Those favouring a tough line on rates from the ECB have argued it was greed that provoked the current global crisis.

The banks globally were complicit with the decade-long lending spree in the US from which they enjoyed good returns.

Subsequently the level of responsibility with some banks started to surface when it emerged those with bad credit histories and many with no credit histories were lent money as if there was no tomorrow.

As the extent of the crisis hit the headlines, the US central bank started to cut rates — from 5.25% to 3% with more reductions due.

Some experts argue the only thing missing from the equation has been a similar interest rate cutting policy by the ECB to counter falling growth.

During the last crisis, when the Fed pushed rates to a 45-year low of 1%, the ECB lowered its key lending rate to 2% in June 2003.

Until September last the ECB and the US had been raising rates as fears grew that the credit Fed boom was about to end in tears.

Ironically, the excesses of the past are forcing the Fed to cut rates rapidly again. History shows the Fed was too late in hiking rates up in the past few years and the damage was already done in the intervening period which has manifest itself in the current property bubble.

Hopes the ECB would cut rates to boost growth took a further knock when the governing councils of the ECB left the markets in no doubt inflation was still its chief worry.

ECB president Jean Claude Trichet said not slowing economic growth was the bank’s primary concern.

Simon Barry, economist with Ulster Bank, says rumours of rate cuts by the ECB this year look to have been exaggerated, given inflation figures will be well above the 2% mandate of the bank for the next two years.

Others still believe rates will be back down to 3.5% from 4% by the year end.

The clearest message from the ECB throughout this crisis is it is its own master, and will not be pressurised into lowering rates to rescue the banking sector and borrowers from the consequences of their own greed and stupidity.