THE iron discipline we have come to expect from the European Central Bank has broken down, giving an unprecedented public glimpse of feuding over the direction of monetary policy in the financial crisis. As the 16-nation euro zone's central bank dangles its toes in the uncharted waters of quantitative easing – starting to buy assets in an attempt to help revive the economy – its leaders cannot agree on how far to go and when to stop. As a result, ECB President Jean-Claude Trichet was only able to announce a minimal consensus on May 7 when the bank cut its key interest rate by 25 basis points to 1.0 percent and said it would for the first time buy 60 billion euros in covered bonds. Trichet insisted this “enhanced credit support” was adopted unanimously and said: “We are not at all embarking on quantitative easing.” As the ensuing cacophony showed, the central bankers did not agree on whether 1.0 percent should be the floor for rates, whether the bank should signal it would keep rates there for a sustained period, how to conduct the covered bond purchase or whether to go further in credit easing. Torn between the twin threats of recession and a potential return of inflation, the ECB remains extremely reluctant to follow the US Federal Reserve and the Bank of England in creating money on a massive scale to revive economic growth. The debate pits guardians of inflation-fighting orthodoxy such as German Bundesbank chief Axel Weber and ECB executive board member Juergen Stark, against advocates of a bolder monetary easing, including executive board member Lorenzo Bini Smaghi and Cypriot central bank governor Athanasios Orphanides. It highlights the difficulty of building consensus and taking decisions in a 22-member governing council – a larger and more unwieldy body than the Fed and Bank of England committees that set monetary policy. Ghost of future inflation The ECB's security purchases will amount to just 0.6 percent of the euro zone's Gross Domestic Product, compared with 9 percent in Britain and 12 percent in the United States. Clearly, some of Europe's central bankers are still more worried about the ghost of future inflation, even as price growth is poised to turn negative for some time, than about shrinking output and soaring unemployment. The euro zone economy is forecast to contract by 4 percent this year and unemployment is projected to reach 11.5 percent of the workforce in 2010. Yet the inflation hawks want the ECB to agree on an exit strategy from monetary easing even before starting asset purchases. They also contend that buying securities has less impact in Europe than the United States because of the structure of the economy and the banking system. Unlike the Anglo-Saxon central banks, the ECB does not publish minutes or voting records, which signal to markets the range of views and the likely direction of policy. So the unusual public spat among ECB policymakers in recent days provides a rare insight into the depth of differences on the way forward. Consider last week: * Dutch central bank governor Nout Wellink said the ECB should discuss rates below 1 percent, after Germany's Weber said on April 27 that 1.0 percent was “a sensible lower limit”; * Slovenia's Marko Kranjec said the ECB was likely to spend more than 60 billion euros and might purchase other assets as well as covered bonds, while Austria's Ewald Nowotny said no further steps were being discussed and Weber said 60 billion was “the maximum”; * ECB vice-president Lucas Papademos said there were signs the worst was over for the economy, but Wellink retorted: “Don't become too optimistic when you see a few swallows.” Green shoots How long the recession is expected to last affects the scope and the nature of measures the bank may adopt. Interest rate cuts take 18 months to two years to have an economic effect while asset purchases have an immediate impact. First signs of “green shoots” of economic recovery would tend to support the ECB's caution. Indeed, markets have already responded before the ECB's covered bond programme has begun. Yield spreads have fallen and issuers are rushing to market in anticipation. Is the ECB's policy debate a sign of weakness and dithering while its US and British counterparts act decisively, or a sign of prudence? Perhaps it is refreshing that ECB policymakers are airing these issues in public rather than presenting a monolithic facade of unison. The executive board's Stark sought to make a virtue out of the unusual dissonance.
