Two Europe banks to inject new cash in bid to thwart recession

Frankfurt: With Europe sliding towards recession, the region's two main central banks are preparing to redouble their emergency measures aimed at softening the downturn and blunting the effects of the government debt crisis.

Analysts expect the UK's central bank, the Bank of England, to announce today that it will inject another £50 billion (Dh292 billion) of new money into an economy that shrank at the end of last year.

Also meeting at its headquarters in Frankfurt, Germany, the European Central Bank is expected to trumpet the advantages of its second unlimited offering of cheap, three-year loans to be allotted to banks on February 29.

Neither central bank is expected to change interest rates from their current record lows — the Bank of England at 0.5 per cent and the ECB at 1.0 per cent. Rather, attention will focus on their outlooks and their attempts to push more money into the banking systems and the economy.

A first blast of cheap ECB credit — $641.23 billion — was taken up by 523 banks on December 23 last year. The step has been credited with calming some of the market panic from the debt crisis hitting the 17 countries that use the euro, and stocks and government bonds have risen since then. Analysts think the take-up could equal or exceed the first one, since the ECB has loosened collateral requirements.

Worrying signs

Despite a remarkable easing in tensions on fin-ancial markets this year — particularly evident in the big drop in the borrowing rates of weak countries like Italy and Spain — the 17-country Eurozone and the UK face worrying signs from the wider economy.

The Eurozone economy is widely expected to have contracted in the fourth quarter, while the UK shrank 0.2 per cent in the last three months of last year. Many analysts predict both regions will fall into a technical recession — defined as two consecutive quarters of negative growth — by the end of March.

Both remain exposed to any sudden shock from the crisis in Europe over too much government debt — financial volatility quickly causes credit to seize up, stifling economic activity.

A messy default by Greece — currently in drawn-out talks with other Eurozone governments, the ECB and the International Monetary Fund about a second bailout — would threaten the integrity of the Eurozone, shaking British and world markets as well.

Recent economic indicators for Britain and the Eurozone have suggested things may pick up a bit in the months ahead, but big risks remain.

Credit availability, crucial to help businesses expand and create jobs, appears to be dropping in the Eurozone. An ECB survey of banks indicated that the number tightening lending requirements surged at the end of last year, to a net 35 per cent from 16 per cent.

Andrew Goodwin, senior economic adviser to the Ernst & Young ITEM Club, said Britain still needs a further shot of stimulus thanks to the commotion across the Channel. "Short-term prospects remain on a knife-edge given the ongoing policy paralysis in the Eurozone. If the crisis deepens, it would most likely reverse all of the pick-up seen in the last couple of months," he said.

Analysts think the Bank of England will create new money to buy securities — mostly British government bonds — from private investors such as insurance companies and pension funds, on top of the £275 billion it has already purchased.

Quantitative easing

The hope is that the purchases, known as quantitative easing or QE, will increase the amount of cash flowing through the financial system, which will in turn help lower interest rates and borrowing costs for businesses and raise asset prices. Quantitative easing can be inflationary, but analysts say the bank has room to act as inflation is widely forecast to fall from 4.2 per cent towards the official two per cent target over the next two years.

Vicky Redwood, chief UK economist at Capital Economics, said inflation "is expected to fall some way short" of target. "Accordingly, we think the big picture will be that further QE is still needed," he added.