Euro loan exit talk ‘premature’

European Central Bank President Mario Draghi said it was far too soon to talk about an exit from its massive emergency loans to banks, saying that any such move would be premature while the 17-country eurozone was struggling with slack economic conditions and record high levels of unemployment.

Draghi, speaking after the ECB left its key interest rate unchanged Wednesday at the record low of 1 percent, said the bank was still sizing up the “powerful and complex” effects of the €1 trillion ($1.3 trillion) in loans it handed out in two batches to banks on Dec. 21 and Feb. 29.

But he said it was clear that “given the present conditions of output and unemployment, which is at an historical high, any exit strategy talk is premature.”

He went on to say that the recent dip in bond market confidence — and the higher costs of borrowing that heavily indebted Italy and Spain have to pay to raise money — were signs that investors were pushing for faster reforms by governments, both in cutting their deficits and clearing away barriers to competition.

“I would read the recent developments not so much as an example of market fragility, but as an example that markets are expecting reforms. What markets are saying is, the markets are asking these governments to deliver, basically. And so it’s fiscal consolidation, it’s structural reforms.”

Draghi said current market conditions were not a sign of market unease or fragility “but rather market attention upon fundamentals.”

The bank is regarded as in a holding pattern since cutting rates in November and December 2011 and making the cheap three-year loans available to hundreds of banks. The loans eased a credit crunch crippling the eurozone at the end of last year and steadied the region’s banking system. But top ECB officials have said they don’t expect the money to immediately lead to credit expansion in a slack economy. Banks are hesitant to lend and businesses are seeing little reason to borrow in an uncertain environment.

Draghi called the loans — longer-term refinancing operations, or LTROs — “complex and powerful measures which have affected all the funding channels, all the items of the balance sheets of banks in a variety of ways. We have to look at exactly what is happening here.”

His statement seemed to put a lid on recent remarks by top ECB officials — including some by Draghi himself — that emphasized the bank could quickly drain the money it had poured into the banking system before the excess cash has a chance to push up inflation. Analysts say those earlier exit remarks may have been aimed at discouraging expectations of more LTROs.

Jens Weidmann, the head of Germany’s Bundesbank, has stressed the risks of the loans and said the bank needs to discuss how to exit the emergency support measure. Weidmann, who joined the unanimous ECB council in supporting the loans, has also cautioned that the LTROs risk propping up unsustainable banking practices and weakening government resolve to reform.

Draghi repeated his earlier economic outlook, saying that the bank expects a gradual recovery this year in the eurozone from low levels of economic activity, but that there are still risks for a turn for the worse.

The eurozone economy shrank 0.3 percent in the fourth quarter and indicators for future growth indicators remain weak, raising the likelihood that the economy shrank again in the just-finished first quarter. Two quarters of falling output are a technical definition of recession.

Unemployment is at a record 10.8 percent for the 17 countries that use the euro, while youth unemployment has reached unprecedented freakish levels of 50 percent in Spain and Greece.

The bank is unlikely to cut rates unless there’s a significant turn for the worse. In part, that’s because annual inflation of 2.6 percent remains stubbornly above its goal of just under 2 percent. The bank blames higher oil prices, not inflationary pressures from the economy.

Government officials in indebted countries are concerned that slashing budgets and raising taxes to reduce debt and satisfy bond investors may hurt growth in the coming months as well. That would make it harder for indebted countries to dig out of the debt woes that have pushed Greece, Ireland and Portugal to take international bailout loans and raised concerns about Italy and Spain’s ability to borrow affordably to maintain their own debt burdens.

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