Why Are U.S. and European Central Banks Going In Opposite Directions?

As the EU battles to keep inflation near its 2 percent benchmark, the European Central Bank announced a firm commitment today to maintain support for its ailing economy.

ECB Executive Board member Peter Praet reaffirmed the need for the euro zone to avoid deflation and increase lending en route to a healthy recovery, two factors which show stagnant growth currently. From January 2013 to April, inflation in the EU has fallen from 2 percent to 1.2 percent, marking a period of decline not seen since 2008.

While dismissing immediate concerns of a deflationary crisis, Mr. Praet did say, “We have an objective: price stability,” stating the ECB would look to whatever devices necessary to maintain that goal.

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Praet’s comments follow testimony from U.S. Federal Reserve Chairman Ben Bernanke, who has indicated his central bank may now ease up on its efforts to prop up the U.S. economy. Mr. Bernanke admitted the bank will slow down the rate of its $85 billion dollar bond buyback program, otherwise known as ‘quantitative easing,’ if the prospects for economic growth continue to look up. GDP growth grew at 2.5 percent in the first quarter of 2013 in the United States, despite the fiscal squeeze from Washington, with personal expenditures among consumers rising 3.2 percent.

As recession continues to plague Europe, though, lending continues to be weak, and the central bank is looking for ways to generate activity in the sector, reaffirming its commitment to provide unlimited funds to banks for another year. However, despite having access to unlimited capital from the central bank to finance lending projects, loans in the range of .25 million to 1 million euros have continued to decline since 2010.

loan_volume_with_collateral

Source: http://ec.europa.eu

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Interest rates also remain low, with the refinancing rate at 0.5 percent in hopes that such rates will promote risk-taking and expansion. The ECB is now also looking at allowing banks to borrow increased amounts of money against a singular amount of collateral, a move which is designed to allow banks to get more cash.

Yet policy-making and domestic economic pictures continue to hamper the best efforts of the ECB, specifically in France, where record unemployment has taken hold, and President Francois Hollande’s administration defends itself from being anti-business.

France is not alone, though, as Spain suffers all the woes which define the current European Recession.

The Spanish economy saw a contraction of 0.5 percent in the first quarter of 2013, as consumer spending has slowed, housing prices are on the decline, and unemployment continues to rise. Analysts are now postponing the prospects of stability in the Spanish economy until 2014, as S&P recently showed that housing prices in some areas have fallen by as much as 40 percent. Many families are unable to sell their homes while maintaining mortgages now worth more than the home’s value.

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Speaking on the prospects of the ECB relaxing its actions, Austrian central banker Ewald Nowotny said, “In my view this is not yet the case at the moment (to do so).”

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