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Jean-Claude Trichet, President of the European Central Bank (ECB) folds his hands as he listens to reporter's questions during his monthly news conference at the ECB headquarters in Frankfurt, February 3, 2011. (KAI PFAFFENBACH/REUTERS)
Jean-Claude Trichet, President of the European Central Bank (ECB) folds his hands as he listens to reporter's questions during his monthly news conference at the ECB headquarters in Frankfurt, February 3, 2011. (KAI PFAFFENBACH/REUTERS)

ECB moves to keep cash taps flowing Add to ...

Facing recession and a growing financial crisis, Europe’s central bank took steps to keep cash flowing to the ailing banking sector, but resisted calls for an interest-rate cut to spark the slumping economy.

The European Central Bank’s decision to supply new funding for major banks in need of capital provided another sign that policy makers are getting serious about tackling the banking crisis, and helped fuel another day of sharp gains in European and North American stock markets.

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The move comes as European officials moved closer to devising a comprehensive rescue plan for the region’s banks. European Commission president Jose Manuel Barroso said a co-ordinated effort to recapitalize banks is “not only obvious, but indispensable.”

Bank woes are quickly spreading from smaller regional banks in peripheral countries such as Spain and Portugal to the financial centers of Europe. On Thursday, regulators suspended trading in the shares of Franco-Belgian lender Dexia SA as officials try to work out an orderly breakup of the bank, which has been dragged down by a portfolio of devalued European sovereign bonds and depleted reserves. The imminent dismantling of Dexia is expected to cost taxpayers in both countries.

Parts of the euro zone are already in recession, but the ECB’s soon-departing president Jean-Claude Trichet opted to leave its key rate unchanged. The decision left many analysts scratching their heads as to why Mr. Trichet, who cedes his job to Italy’s Mario Draghi at the end of October, didn’t do more on the interest rate front.

“Once again the ECB appears behind the curve given the concerns about growth,” CMC Markets analyst Michael Hewson said. “I’m guessing Trichet didn’t want to be remembered for admitting that this year’s rate hikes were a mistake and has given the dubious honour of reversing them to his successor Mario Draghi.”

As recently as three months ago, Mr. Trichet judged that the greatest threat to the euro zone was inflation. And the ECB raised its key interest rate to 1.5 per cent to fight it.

Now the threats are recession, bank failures, sovereign defaults and the breaking up of the euro zone.

In his final press conference at the helm of the ECB, Mr. Trichet defended his decision, pointing out that rates are already low and that the ECB’s record is “fully credible in terms of price stability.” Inflation is running at 3 per cent a year in the euro zone. But it’s hardly uniform across the region, with several countries gripped by recession and falling prices.

The Bank of England, meanwhile, also left its key rate unchanged Thursday. But Britain’s central bank ramped up its quantitative easing measures, with plans to buying another £75-billion ($120-billion) of government bonds from banks in order to provide liquidity in the financial system. BOE chief Mervyn King said the U.K. is facing the worst economic crisis since the 1930s.

The ECB is also getting more aggressive in its use of unconventional easing techniques, responding to evidence of a freezing-up of some lending between banks amid Dexia’s struggles. The ECB said it would spend €40-billion ($56-billion) over the next 12 months to buy so-called covered bonds, a form of debt secured by payments from batches of loans and a common source of funding for European banks.

The ECB said it will reintroduce year-long loans, giving banks access to unlimited cash through January, 2013.

Some analysts were critical of Mr. Trichet’s move to hold the line on interest rates, and his legacy. Nouriel Roubini, the New York University professor and chief of Roubini Global Economics, fired off a flurry of unfavourable Twitter updates.

“Trichet leaves giving a finger to the markets, thus leaving to Mario [Draghi] the dirty job of doing the right thing,” Mr. Roubini wrote.

Later, Mr. Roubini added: “That man’s ego prevents him from doing the right thing for the euro zone. The legacy he leaves us with: shortsightedness.”

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