ECB opens the tap

European stock markets held onto gains in early Friday trading following the European Central Bank's announcement to provide liquidity to European banks in the face of the ongoing debt crisis.

Outgoing ECB chief Jean-Claude Trichet played several trump cards but not the entire hand, however, in his final policy meeting as the bank's president. Trichet announced a plan to offer unlimited one-year loans to European banks through 2013 and said the ECB would buy up another 40 billion euros ($54 billion) in "covered bonds," but he stopped short of lowering eurozone interest rates even further from their current level of 1.5 percent.

"The economic outlook remains subject to particularly high uncertainty and intensified downside risks," Trichet said at a news conference in Berlin after meeting with a host of leading economic lights and Chancellor Angela Merkel.

But the outgoing ECB head was keen to stress that his organization could only help alleviate the symptoms, not tackle the disease.

"All the non-standard measures taken during the period of acute financial market tension are, by construction, temporary in nature," Trichet cautioned, saying the ECB "urges banks to do all that is necessary to reinforce their balance sheets."

He also said that governments around Europe "need to take decisive and front-loaded action to bolster public confidence in the sustainability of government finances."

Under the measures outlined by Trichet, the ECB will make two new injections of low-interest credit available to struggling banks until 2013, in the hope that this will shield them from malfunctioning credit markets where inter-bank loans dry up, ultimately impacting on high-street credit for small business and mortgages.

"I think that if banks really need support, then that is what European governments should offer, and it will be money well invested," Chancellor Angela Merkel said of the new credit plan. "Indeed the costs that otherwise would result - if we didn't tell the banks to recapitalize, or didn't as a last resort support them with government money - would be much higher. But the first step should, of course, be for the banks to recapitalize themselves."

The ECB will also buy 40 billion euros of so-called "covered bonds," assets backed by mortgage loans or public sector lending, which are usually perceived to be a safe investment.

Keeping powder dry for Draghi?

The major move that Trichet decided not to take was to lower the eurozone interest rates further from their already clement level of 1.5 percent. He said that there had been discussion on this issue within the bank, and that the committee was divided over how to move forward. He pointed to one reason why they would stay put for the time being.

"Inflation has remained elevated … and is likely to stay above 2 percent in the months ahead, but to decline thereafter," Trichet said.

Inflation hit 3 percent last month, well above the ECB's target level of roughly 2 percent. Analysts, however, suspect that the ECB will eventually gamble on a rates cut, despite rising inflation. Some believed that Trichet's decision to hold the line was designed to keep some weapons in the arsenal of his successor, Mario Draghi. The current Bank of Italy governor takes over Trichet's role in November.

"Falling leading indicators suggest that the ECB will lower its expectations for economic activity considerably," Commerzbank chief economist Jörg Krämer said. "The ECB will presumably cut its key [interest] rate towards year-end and again next spring."

IMF Managing Director Christine Lagarde, World Bank President Robert Zoellick, the secretary general of the Organization for Economic Cooperation and Development and the finance ministers of France and Mexico were among the other participants at Thursday's meeting in Berlin.

Author: Mark Hallam (AP, dpa, Reuters)
Editor: Nancy Isenson