ECB Said to Discuss Putting Adjustable Rate on 12-Month Loans

By Jana Randow and Gabi Thesing
Nov. 25 (Bloomberg) -- European Central Bank officials are debating whether to put an adjustable interest rate on December’s 12-month loans, with some saying it risks being interpreted as a signal they will tighten monetary policy in 2010, according to people familiar with the discussions.
As the ECB moves closer to withdrawing emergency support for the economy, officials are examining whether to make the rate on next month’s loans track any increase in the bank’s key rate. While a final decision hasn’t been made, the 22-member Governing Council is leaning toward sticking with a fixed rate of 1 percent, said the people, who declined to be identified because the discussions are private.
The ECB is offering banks unlimited funds for 12 months as part of its strategy to get them lending again. Some officials fear putting a floating rate on the loans would prematurely fuel expectations that the ECB will lift its benchmark rate from 1 percent next year, which could in turn raise the cost of money on markets and propel the euro higher. The risk of lending at a fixed rate is that it may undermine the effect of any increase in the benchmark should the ECB deem it necessary.
Altering the rate "is always going to be interpreted as a signal for future monetary policy," said Laurent Bilke, an economist at Nomura International in London who used to work at the ECB. "The only way to avoid that problem is to continue as they have been doing."
An ECB spokeswoman declined to comment.

No Signal

Policy makers have already agreed that the December 12- month tender will be the last, even though some wanted to retain the option of using the tool again.
The bank may also reduce the frequency of its three-month and six-month tenders next year to one of each per quarter, one of the people familiar with the deliberations said.
While scaling back lending operations is the first step in the ECB’s exit strategy, officials don’t want to signal rate increases are in any way imminent, the people said.
At the same time, there are diverging views on the Governing Council over how long to leave the ECB’s expansionary policies in place.
Executive Board member Juergen Stark said on Nov. 17 that the response to the crisis "should not sow the seeds for new imbalances," and the ECB is "moving closer to phasing out our liquidity measures."
Others on the council, such as Athanasios Orphanides of Cyprus, are concerned that the economy is too weak to drive inflation back toward 2 percent, the ECB’s medium-term goal.

Key Plank

The central bank’s survey of professional forecasters shows inflation is expected to average 1.6 percent in 2011.
The 12-month loans are one of the key planks in the ECB’s response to the financial crisis. They allow banks to borrow as much money as they want for a year at the benchmark rate. The ECB retained the option of adding a spread to the rate on the December loans, the third offering, which would help to limit demand. A spread is considered unlikely, the people said.
Another option being examined is to tie the rate on the loans to market rates. Council members will probably reject that because it’s too complicated, the people said.
Banks drew 75 billion euros ($112 billion) in September’s 12-month tender, down from 442 billion euros in the first tender in June, which was the highest amount ever allotted in an ECB refinancing operation.

‘I Exclude Nothing’

The 16-nation euro region emerged from its worst recession since World War II in the third quarter. Economists expect the ECB to raise its key policy rate in the third quarter of 2010, according a Bloomberg News survey.
Under that scenario, if the ECB elected to lend the 12- month funds in December at a fixed 1 percent, banks would have cash for at least three months at a cheaper rate than the ECB’s key rate.
ECB President Jean-Claude Trichet said this week he’ll give details on the next tranche of 12-month loans after the bank’s Dec. 3 policy meeting in Frankfurt.
"We will decide on whether or not we will have indexed rates or fixed rates like we did before," he said in Madrid.
"I exclude nothing."