FRANKFURT, Jan 1 (Reuters) - The European Central Bank faces another crucial year in 2011. Below are the five key issues facing the bank as it tries to steer the euro zone out of the ongoing debt crisis.
TROUBLE IN THE EMPIRE
The turmoil suffered by Greece, Ireland and Portugal has highlighted the difficulties the financial crisis has pushed some euro zone countries into and the inherent fault lines that exist within the currency union.
Were the troubles to escalate and spread to Spain or even Italy, they would begin to raise serious doubts about the future of the euro and could push the ECB to take previously unthinkable action.
COMMENTS
Intesa Sanpaolo economist Paolo Mameli:
"The fate of the European Union seems to depend critically on Spain."
"An "effective" speculative attack on Spain would be a different matter (to Portugal), as the funds currently planned for the European Financial Stability Facility would be barely sufficient for a bail-out; it therefore seems that Spain represents a sort of Maginot Line for European monetary union.
"The only scenario in which the ECB would be willing to cross the Rubicon (i.e. make massive (government bond) purchases and not sterilise them) would be the extreme case in which the contagion affected not just 'minor' sovereign markets like Greece, Ireland and Portugal, but also the debt of a major economy like Spain
"But this is an extreme scenario (the nuclear option to 'save' Monetary Union) and one which not just the ECB but other European institutions too would do everything in their power to avoid."
WITHDRAWAL OF CRISIS SUPPORT MEASURES
The ongoing debt and financial market turbulence forced the ECB to abandon its plans to reduce the support it offers to banks at the end of last year.
Its controversial government bond purchase programme is also ongoing despite heavy resistance in some quarters of the central bank.
With government debt fears still topping the agenda and question marks hanging over the strength of the euro zone's economic recovery and some of its banks, the speed at which the ECB will be able to drop its remaining support -- including providing banks with limit-free funding -- is seen as another of the year's major issues.
COMMENTS
JP Morgan economists Greg Fuzesi and Nicola Mai:
"As in 2010, the ECB in 2011 will again feel no pressure from the inflation and growth outlook to add additional monetary stimulus to the economy. Hence, large-scale asset purchases will remain off the agenda. And while it will remain generous with its liquidity provision at first, it will be eyeing the exit from the remaining nonstandard measures."
ING economist Martin Van Vliet:
"The ECB could well end up staying as the lender and investor of last resort... The end game is turmoil in the bond and currency markets."
DIVERGING ECONOMIES
While the euro zone's largest economy, Germany, continues to power forward, countries in the midst of deficit-cutting drives such as Ireland, Greece and Portugal face the grey prospect of recession or extremely feeble growth.
The split has created a three-speed euro zone and the prospect that the weaker, debt-strained economies will continue to arc away from the likes of Germany. It leaves the ECB facing the impossible task of trying to pitch policy that is right for all.
COMMENTS
ING economist Martin Van Vliet:
"If the divergence and the gap between the North and South of the euro zone continues to widen, it makes it even harder for one size-fits-all approach to monetary policy.
"One of the concerns on the minds of Axel Weber and Juergen Stark is that the German economy does not need as loose a monetary policy as the rest of the euro zone.
"It's a bit of a Goldilocks situation for the ECB. Monetary policy is going to either be too hot or too cold. The problem is it may not be able to be just right at the moment."
Ernst & Young Eurozone Forecast economist Marie Diron:
"Germany is driving the Eurozone economic recovery with GDP growth of 3.5 percent forecast this year and 2.1 percent next ... Countries closely linked to the German economy, in particular Slovakia and Austria, are also predicted to grow steadily in 2011. More modest growth is forecast in other major 'Northern' countries, including France and Netherlands (both 1.8 percent).
"Growth in the peripheral countries in 2011 ... ranges from -3.3 percent in Greece to -0.7 percent in Portugal. This could be considerably lower if the peripheral economies face renewed turmoil in bond markets and need to implement yet additional deficit tightening measures."
RATE HIKES ON THE HORIZON
According to the latest Reuters poll, economists currently see the ECB raising euro zone interest rates in the final quarter of the year. [POLL/ECB] However, the exact timing will depend on how the euro zone's recovery progresses and whether recent stronger-than-expected inflation in countries such as Germany evolves into anything more threatening.
COMMENTS
JP Morgan economists Greg Fuzesi and Nicola Mai:
"We expect the main policy interest rate to remain at 1 percent during 2011. But, our conviction is not very high on this call as it is conditional on core inflation falling back slightly during the year. And it assumes that the ECB will not become too concerned about potential distortions arising from the very low level of interest rates."
Ernst & Young Eurozone Forecast economist Marie Diron:
"The robust growth results of the first part of 2010 may have encouraged the ECB to believe that the recovery was well engaged and that the Eurozone could support tighter monetary conditions. However, the Irish crisis has highlighted the fragility of the Eurozone economy and the need for monetary policymakers to use all weapons available to buffer the negative impacts."
LEADERSHIP RACE
Jean-Claude Trichet's term as ECB President runs out at the end of October. Germany's Axel Weber and Italy's Mario Draghi remain front-runners to be his replacement, although Weber's outspoken views about the ECB's government bond purchases in recent months appear to have downgraded him from the tag of clear favourite.
Whoever gets the nod from euro zone politicians will take over at crucial juncture for the ECB as it tries to get the economy and its monetary policy back on a more even keel. The individual's policy bias will also shape market expectations about how the ECB will approach interest rate setting and the level of other support it is likely to provide going forward.
COMMENTS
ING economist Martin Van Vliet:
"It will get tricky when Trichet steps down at the end of October. If a German such as Weber picks up the baton the risks would be higher than if Draghi or (ECB governing council member Nout) Wellink took the job.
"Weber has made it clear he is uncomfortable with some of what the ECB is doing.
"If a hawk followed Trichet it would not necessarily be good news for the suffering periphery countries." (Reporting by Marc Jones; Editing by Dan Grebler)