ECB holds interest rate

Bank confirms buying eurozone bonds.

Speaking at a press conference in Frankfurt, Jean-Claude Trichet, the president of the European Central Bank (ECB), said that there had been a deceleration in the pace of economic growth in the last quarter but that the ECB’s decision to raise rates in July was warranted by price developments.

Bond-buying

Trichet also confirmed that the ECB was buying government bonds, saying that the bank had not suspended an earlier bond-buying programme. “I never said myself it was dormant,” Trichet said.

The bond-buying programme is seen as a response to uncertainty in eurozone bond markets which has seen a sell-off in Italian and Spanish government bonds. Yields, which move inversely to price, have soared to record levels as investors demand a higher premium to hold assets considered at greater risk of default.

The ECB started raising interest rates in May, from a record low of 1% in April, in response to rising inflation, caused largely by energy price increases.

Analysts are expecting the ECB to raise its main rate by a further 0.25 percentage points to 1.75%. Trichet indicated that the ECB had not ruled out further increases, saying that there was a continued need for caution against price pressures. “[Inflation] risks remain on the upside,” he said.

He admitted that growth was expected to be lower in the second quarter of 2011 compared to the first. “The first quarter was exceptionally buoyant and we were expecting a progressive slowing down”, he said. “It will be a quarter with significant growth,” he said.

He added that short-term interest rates were still low by historical standards.

Extended refinancing

Trichet explained that the ECB had decided to extend its refinancing programme for the fourth quarter of 2011 in response to the situation on eurozone bond markets. “We estimated that, given the renewed tensions in some financial markets, the appropriate response was that we prolong [the refinancing programme] for one additional quarter,” he said.

He admitted, however, that the decision to extend the programme had been supported by a majority of the members of the governing council, not unanimously.

Asked if he thought that the eurozone had the right instruments in place to stop contagion, Trichet said that eurozone governments had the primary responsibility for ensuring stability. “The governments have to do their job,” saying they had to be “ahead of the curve” on measures to improve public finances and structural reforms to boost growth. He said that governments that had carried out “politically difficult reforms” had been rewarded by “in a brilliant fashion” by better economic performance.

Italy

With Italian bonds having come under particular pressure in the markets, Trichet was asked if Italy as “ahead of the curve”. Trichet said that structural reforms were “very important” for Italy, noting that the country’s long-term growth rate did not correspond to its growth potential.

Trichet said that the ECB had welcomed the agreement struck by eurozone leaders on 21 July to a number of measures to defend stability in the eurozone. Leaders agreed to expand the flexibility of the eurozone’s €440 billion rescue fund, the European Financial Stability Facility (EFSF). Trichet said that these changes to the EFSF should be operational as soon as possible and called on eurozone governments to implement them. “We expect all decisions to be executed fully in all their dimensions in a very effective fashion,” he said.

José Manuel Barroso, the president of the European Commission, wrote to eurozone leaders yesterday, urging them to approve the changes as soon as possible.

Trichet was asked about whether the ECB would end its bond market purchases once the EFSF was able to buy bonds on the secondary market. He said that the ECB’s “working assumption” was that once the decision to allow the EFSF to buy bonds n the secondary market had been implemented “it would eliminate the reason why we are intervening”.

He pointed out that eurozone leaders had agreed that the EFSF would be able to buy bonds based on an analysis prepared by the ECB and provided there were exceptional market circumstances.  

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