By Ambrose Evans-Pritchard
Last Updated: 8:04PM GMT 23 Feb 2009
For months the ECB held sternly to the high ground of orthodoxy as the US, Japanese, British, Canadian, Swiss and Swedish central banks slashed rates towards zero and embraced quantitative easing, but a confluence of fast-moving events is now forcing it to move.
The credit default swaps that measure bankruptcy risk on the debts of Ireland, Austria and a clutch of Latin Bloc states have vaulted to dangerous levels. In the case of Ireland, the slump is spilling on to the streets. Some 120,000 marched through Dublin over the weekend to protest austerity measures.
The slow fuse on Eastern Europe's banking crisis has detonated, leaving Austrian, Belgian, Italian and other West European banks with $1.5 trillion (£1 trillion) in exposure.
It is happening just as industrial output collapses in the eurozone's core states. Germany's economy contracted at 8.4pc annualised in the fourth quarter. ECB president Jean-Claude Trichet said on Monday that "a process of negative feedback" has set in where the banks and the real economy are pulling each other down in a self-reinforcing spiral. Eurozone credit is contracting. Banks are rationing credit as deleveraging gathers pace.
Rob Carnell, global strategist at ING, said the ECB has been painfully slow to acknowledge the global deflation tsunami sweeping across Europe.
"It seems divorced from reality. It is clearly nonsense to talk about inflation now: it has been negative on average for six months. The eurozone purchasing managers' index has fallen twice as fast as in the US, so the ECB should be acting even faster than the Fed," he said.
Mr Trichet said the ECB has increased its balance sheet by €600bn (£525bn) since the Lehman collapse in September. The bank is providing "unlimited liquidity" in exchange for a wide range of collateral, including mortgage bonds issued for the sole purpose of extracting ECB funds.
But the ECB's leading voices have adamantly refused to contemplate going to the next stage: buying bonds and other assets with "printed money". They see that as the Primrose path to hell. This week the tone has abruptly changed, suggesting that a majority of the 16 national bank governors on the ECB council are having second thoughts.
The apparent ring-leader is Cypriot member Anastasios Orphanides, a former Fed official and a world authority on deflation traps. He said on Monday that the ECB may have to go beyond "zero-bound" rates and revealed that an "internal discussion" was under way.
Italy's Mario Draghi is in the "activist-easing" camp. "The experience in the US in the 1930s and Japan in the 1990s suggests that it is necessary to fight, in the early phases of the crisis, the tendency for real interest rates to rise," he said.
Finland's Erkki Liikanen is of the same opinion. "We are facing the worst financial crisis in our time. It is important not to exclude, ex ante, any measures."
Julian Callow from Barclays Capital said 10 ECB governors are now doves.
This amounts to a mutiny against the Bundesbank-dominated executive in Frankurt. It is no great surprise. They have to answer to their democracies. The plot is thickening.