ECB May Announce Measures to Stimulate Bank Lending

The European Central Bank may announce measures tomorrow to stimulate bank lending, said three officials with knowledge of policy makers’ deliberations.

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Their options range from loosening collateral criteria so that financial institutions have more access to cheap ECB cash, to offering them longer-term loans to grease the flow of credit to the economy. Many economists are predicting an interest rate cut, which two officials confirmed is likely, with only the size of the reduction yet to be determined.

The ECB is focusing on clearing obstacles to bank lending rather than increasing its government bond purchases as a means of tackling Europe’s debt crisis. The central bank’s insistence that governments take their own steps to restore investors confidence seems to be working, as Italian and Spanish yields plunged after France and Germany agreed to move the 17-nation euro area toward a fiscal union.

After a meeting in Paris on Monday, French President Nicolas Sarkozy and German Chancellor Angela Merkel announced they had agreed upon a proposal to amend European treaties to tighten budget oversight. In a joint letter to European Council President Herman Van Rompuy, the leaders said they want a decision on the matter at an EU summit starting tomorrow in Brussels so that the measures can be ready by March 2012.

The ECB has indicated that it will act to prevent a credit shortage, saying that doing falls within its monetary policy remit. ECB President Mario Draghi said on December 1 that the central bank had “observed serious credit tightening” recently and is “aware of the continuing difficulties for banks, due to the stress on sovereign bonds, the tightness of funding markets and scarcity of eligible collateral in some financial segments.” Draghi will hold a press conference at 2:30 p.m. in Frankfurt tomorrow, 45 minutes after the ECB’s rate decision is announced.

ECB policymakers may seek to broader the pool of collateral eligible for ECB loans by relaxing rules governing the use of asset-backed securities, officials said. They also might increase the amount of uncovered bank bonds that can constitute a lender’s collateral portfolio from the current 10 percent limit.

The ECB is already lending banks as much as they want against eligible collateral for periods of up to a year. Speaking on condition of anonymity, officials said the ECB is likely to add two-year loans to its arsenal. A three-year loan has also been discussed, though is unlikely to be introduced at this stage.

Last week, Draghi said the ECB would act to maintain price stability “in either direction,” which would apply to “both the setting of official interest rates and the implementation of non-standard ones” — the implication being that the ECB would act as forcefully to prevent a significant undershooting of its 2 percent ceiling as it would to stop an overshooting.

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Thursday’s policy meeting is the ECB’s last scheduled for the year. The central bank will also publish its latest projections tomorrow, including a 2013 inflation forecast that may justify further monetary stimulus.