LONDON (MarketWatch) - The European Central Bank will begin purchases of covered bonds next month, ECB President Jean-Claude Trichet said Thursday, embarking on an unconventional and controversial round of monetary policy making in an effort to boost credit flow within the 16-nation euro zone.
As expected, the ECB on Thursday left its key lending rate unchanged at a record low of 1%. Trichet, in his monthly news conference, said the level was "appropriate."
Earlier, Bank of England policy makers left its key lending rate unchanged at 0.5% and offered no further adjustment to their 125 billion pound ($205 billion) plan to purchase government bonds and other assets.
Meanwhile, the covered-bond purchases will total 60 billion euros and will be completed by June of next year. These will be made up of direct purchases in the primary and secondary markets, Trichet said.
Trichet also said he reiterated the ECB's "fierce independence" to German Chancellor Angela Merkel, after the German leader earlier this week chided the ECB for "bowing to international pressure" in pursuing unconventional policy measures.
Trichet said there were signs the deep euro-zone recession was beginning to moderate its pace, but that he remained extremely cautious. Growth is likely to return in mid-2010, he said.
The ECB staff, meanwhile, slashed its economic-growth forecasts for 2009 and 2010. The ECB staff now expect annual real gross domestic product to contract by 4.1% to 5.1% in 2009 and then range between a further contraction of 1% or growth of 0.4% in 2010, Trichet said, at his monthly news conference.
In March, ECB staff had forecast a 2009 contraction of 2.2% to 3.2%, with GDP ranging between a 0.7% contraction and a 0.7% expansion in 2010.
The ECB announced last month it had agreed in principle to purchase around 60 billion euros in covered bonds but had offered few details.
The central bank sees the covered-bond market as among the most hard-hit casualties of the credit crunch and hopes that the move will help support the flow of credit to the rest of the economy, economists said.
Covered bonds are debt instruments backed by cash flows from mortgages or public-sector loans and are the most important privately-issued bond segment in European capital markets with outstanding issuance of 2 trillion euros, said economists at Deutsche Bank.
French bank BNP Paribas plans to issue a 1 billion euro, five-year covered bond. Earlier this week, Deutsche Bank started selling an inaugural, 1 billion euro, mortgage-backed covered bond.
Covered bonds are viewed as less risky than asset-backed securities because loan risk remains with the originator.
Germany's Pfandbrief market amounts to almost a third of the total euro-zone covered-bond market, according to Danske Bank in Copenhagen. Spain accounts for around 30% and France nearly 15%.
The plan drew criticism. Merkel, who accused the ECB of bowing to international pressure to follow the path of the Federal Reserve and Bank of England, which have embarked on much larger-scale programs of asset purchases.
Trichet said that Merkel, in a telephone conversation, expressed support for the ECB's independence.
Bank of England meets expectations
The Bank of England had been expected to remain on the sidelines after the Monetary Policy Committee decided at its May meeting to expand its quantitative-easing program by 50 billion pounds from its initial level of 75 billion pounds.
In a statement, the central bank said the committee expects the asset-purchase program to take another two months to complete and that the scale of the program "will be kept under review."
Although recent economic data have offered further evidence that the U.K.'s recession is beginning to moderate its pace, the minutes of the May MPC meeting and the most recent Bank of England inflation report underscored concerns over the strength and durability of any economic recovery, economists noted, leading to expectations the central bank could further expand its quantitative easing program in coming months.
