The global recession has dramatically reduced demand and tightened credit, but now monetary officials in the world's three largest economies have signaled that they'll do what it takes to help reverse those negative trends.
A day after China's central bank pledged to keep money flowing into the financial system to sustain growth, the European Central Bank (ECB) said it would buy 60 billion euros or $80.5 billion in covered bonds to increase liquidity in the euro zone, Bloomberg News reported Thursday.
ECB President Jean-Claude Trichet made the announcement after the central bank cut its benchmark interest rate by a quarter point to one percent.
"The governing council has decided in principle that the eurosystem will purchase euro-denominated covered bonds issued in the euro area," Trichet said Thursday at a press conference in Frankfurt, Bloomberg News reported. The euro rose about 1 cent versus the dollar to $1.3406 on the news in mid-day Thursday trading. Trichet also refused to rule out further rate cuts.
Covered bonds are secured property loans or loans to public institutions; historically, they are among the safest corporate bonds available.
ECB delivers when needed
The ECB's decision represents a significant departure from what many economists expected the bank to do. Over the past two months, ECB officials and other European monetary officials bickered over the appropriateness of adding money to the financial system by asset purchases.
"It appears this is how the ECB will enter quantitative easing -- gradually," economist Richard Felson told DailyFinance Thursday. "Demand conditions in the euro zone are such that this was the logical next step, but unlike the U.S., the ECB faced much stiffer criticism from inflation hawks. But it looks like the doves have prevailed, aided by low inflation in Europe."
Felson added that he expects the ECB to announce "at least one, possibly two more bond purchases by the end of 2009," assuming no uptrend in euro zone inflation.
Meanwhile, China, also sensing that its recovery is not robust enough, kept its one-year lending rate at 5.31 percent, and also pledged to make "flexible" use of several monetary policy tools in order to maintain credit growth, the Peoples Bank of China said. The bank said the availability of loans is critical to ensuring that the government's record 4 billion yuan, or $585 billion, stimulus package increases GDP.
Hurt by plunging export sales and weak domestic demand, China's GDP increased just 6.1 percent in Q1 -- the nation's slowest growth rate since 1999.
Monetary/Economic Analysis: It's a time-old Wall Street adage: Don't fight the Fed. Well, the globalization era version is, Don't fight the Fed, the ECB, and China combined. The ECB's decision to buy covered bonds represents, arguably, the best news for the global economy since the U.S.'s near-$800 billion fiscal stimulus package passed earlier this year. The ECB's Trichet, a legendary inflation hawk, nevertheless came through with the "extraordinary monetary means" when needed, so he should be commended. The action, combined with China's monetary measures, will further loosen credit markets -- the lifeblood of commercial operations.