The European Central Bank may initially have been made to look like a wet blanket by the seemingly heroic measures taken by the Fed and the Bank of England, but the recent show of firep
The European Central Bank may initially have been made to look like a wet blanket by the seemingly heroic measures taken by the Fed and the Bank of England, but the recent show of firepower by the ECB makes these efforts pale by comparison, according to Raj Shant, manager of the Newton Continental European Fund.
‘This dispels the myth that the ECB has been a laggard in its policy responses or that it’s simply too bureaucratic to match the aggression of the US and UK central banks,’ he says. ‘In contrast to the central banks of other Anglo Saxon economies, the ECB has been quietly and efficiently flooding the system with liquidity from the onset of the crisis. Its latest enormous salvo means that its balance sheet as a proportion of GDP now exceeds that of the Federal Reserve.’
In an unprecedented step, the ECB opened the monetary floodgates at the end of June to release a whopping EUR442bn into the European banking system – equivalent to around ten per cent of the Eurozone’s narrow money supply in a single day. The one-year repo facility will allow banks to deposit a wide range of assets with the ECB for up to a year in return for cash at an interest rate of just one per cent.
According to Shant, the main reason that so many commentators have mistakenly viewed the ECB as being toothless is because that is precisely what the ECB wants.
‘This is just what the ECB would like the world, especially bond and currency investors, to think,’ he says. ‘Based in Frankfurt and modelled on the Bundesbank, the ECB regards a strong currency and inflation credibility as indispensable to good central banking and sound money supply. Representing so many national governments also gives it a unique freedom: it can do whatever it thinks best because it’s not beholden to any one administration.’
Just weeks ago, the ECB released a report suggesting that Europe’s banks would suffer another EUR283bn in losses by the end of 2010, split between further security writedowns and traditional loan losses. But as Shant points out, these may be alarming figures considering that European banks have not had a US-style stress test and that they are so far behind in raising new equity.
‘If the crisis so far is anything to go by,’ he says, ‘it’s the non-quoted banks, such as Germany’s Landesbanks, which are sitting atop the worst accumulation of toxic assets. So far, it’s been Europe’s taxpayers and not its equity markets that have had to foot the bill for this.
‘It’s also worth remembering that banks tend to go bust because of liquidity problems, not loan losses. This was what did for Lehman Brothers and Northern Rock. Loan losses tend to build more gradually and allow time for remedial action but in one fell swoop, the ECB has just made sure that European banks have unlimited amounts of cheap liquidity right through to the summer of 2010.’