By Eva Kuehnen
FRANKFURT, March 1 Some European Central
Bank policymakers are alarmed that a dramatic loosening of
lending policy stemming from a 1-trillion-euro wave of cash
unleashed into the financial system will fuel imbalances in the
euro zone and stoke inflationary pressures.
Led by Bundesbank chief Jens Weidmann, who was previously a
top advisor to German Chancellor Angela Merkel, they are pushing
for the central bank to think about an exit strategy after it
fed banks 530 billion euros on Wednesday in the second of two
cheap, ultra-long funding operations.
The signs of internal division add weight to what sources
have already told Reuters: that the central bank does not intend
to offer any more cheap three-year cash. The chances of interest
rates dropping below their record low one percent also appear to
The huge take-up at Wednesday's so-called LTRO meant that in
the space of two months the ECB has injected over a trillion
euros into the financial system.
While the twin operations have banished the threat of a
credit crunch, the ECB hawks are worried that the ploy risks
fostering banks forever dependent on external support, fuelling
imbalances between strong and weak euro zone members and priming
an inflationary timebomb for the future.
Weidmann wrote to ECB President Mario Draghi last month to
express concerns about risks stemming from a decision the ECB
took in December to ease rules on the collateral banks must put
up to tap its funding operations, a central bank source said.
That decision, which Weidmann opposed and now wants
reversed, resulted in some 800 banks partaking in the ECB's
second offer of one percent money on Wednesday - a marked
increase from the 523 bidders at the first LTRO in December.
"This shows that there are diverging views on all of this in
the ECB Governing Council and it is not likely go away until the
sovereigns come up with some big measures, which looks
rather unlikely," said Citigroup economist Juergen Michels.
Draghi asked Weidmann to put his views on paper after they
discussed the issue of growing imbalances in the euro zone's
cross-border payment system TARGET2, which have essentially seen
central banks in weaker economies build up liabilities which
could fall on the stronger ones.
The Bundesbank chief believes those risks could be
exacerbated by the looser collateral rules, the source said.
The issue is also being debated more widely in the ECB's 23-man
Draghi can ill afford to ignore the ECB hawks' concerns.
Last year, two German heavyweights on the Governing Council
quit in protest at the ECB's controversial programme to buy
sovereign bonds - a measure they felt came too close to
financing governments. Weidmann too opposes this option.
Some within the ECB have also lost on some key policy
decisions last December - a cut in interest rates to a record
low of 1 percent, and the loosening of the collateral rules.
The Bundesbank also pushed for a higher interest rate on the
3-year LTROs, but failed to convince other Council members.
Draghi only assumed the ECB presidency after
Weidmann's predecessor, Axel Weber, quit early last year,
clearing the way for the Italian to take the helm of the euro
zone's most powerful institution despite the concerns of many in
The Italian risks a deep and damaging split on the Council
if he tests the hawks too far, weakening the ECB just a few
months into his eight-year presidency.
But it may be that after such a dramatic start in policy
terms he too is content to take a back seat now. Certainly, in
public Draghi has consistently put the onus on euro zone
governments to take the lead.
The ECB looks set to leave interest rates on hold at 1.0
percent far into 2013, according to the consensus of more than
70 economists polled by Reuters, who until three weeks ago
forecast a rate cut later this year.
Draghi is already at odds with some powerful voices in
Germany, taking a nonchalant view last month about the TARGET2
The Bundesbank considers the TARGET2 imbalances a symptom of
underlying problems in the currency bloc and is watching them
with increasing concern as they reflect a stronger reliance of
banks in weaker euro zone countries on cheap ECB funding and
growing risks on those countries' central banks balance sheets.
If the euro zone breaks up - which few expect - the larger
national central banks in the 17-country bloc would be left with
a greater share of the potential losses, as they contribute a
greater share of the ECB capital.
Hans-Werner Sinn, president of Germany's influential Ifo
think-tank, has argued that stronger countries such are
financing the deficit extravaganzas of Greece, Portugal and
Ireland via the euro zone cross-border payment system.
Draghi played down these concerns last month, telling the
ECB's monthly news conference: "We, the Governing Council,
thought that the amount of risk that was taken on board was
perfectly acceptable and very well managed."
The Bundesbank wants to assess the idea of peripheral euro
zone central banks providing collateral to those in the bloc's
core as a back-up for the TARGET2 imbalances - an idea they are
unlikely to buy.
THAT'S ALL FOLKS
Weidmann believes the Bundesbank's credibility depends on
the trust of the German people - generally a risk-averse bunch
on financial matters - which he feels duty-bound to uphold.
Against this backdrop, it is perhaps no coincidence that
details of his letter to Draghi emerged in the Frankfurter
Allgemeine Zeitung (FAZ) - a respected German daily.
In his letter, Weidmann called for a return to collateral
rules as they had been before the crisis, the FAZ said.
Weidmann had already expressed concern that "too generous"
supply of liquidity could create risky incentives for banks,
which could in turn store up future inflation risks.
Ewald Nowotny, a member of the ECB's 23-man Governing
Council, went further on Tuesday and said the bank should think
about an exit strategy after its massive cash injections.
Their case may be supported by a pick-up in euro zone
inflation in February to 2.7 percent from 2.6 in January, well
above the ECB's target of just below 2 percent.
Central bank sources have already told Reuters the ECB wants
Wednesday's second LTRO to be its last, putting the onus back on
governments to secure the euro zone's longer-term future.
In the United States, the Federal Reserve is also taking a
cautious view on further policy impetus. Fed Chairman Ben
Bernanke on Wednesday dashed the hopes of some investors who
were betting on more U.S. monetary stimulus.
The ECB hawks' bargaining position could be further
bolstered if Luxembourg's central bank chief, Yves Mersch, takes
over from Spain's Jose Manuel Gonzalez-Paramo on the ECB
Executive Board from June 1.
Mersch, who has one of the strictest anti-inflation stances
among ECB policymakers, is seen as the frontrunner for the post,
which manages the ECB's day-to-day business.