By Johanna Treeck
FRANKFURT (MNI) – The European Central Bank will likely leave its
policy on hold this Thursday after reducing interest rates at its last
two consecutive meetings and opening the liquidity floodgates in
December with a new three-year refinancing operation that pumped nearly
half a trillion euros into the banking system.
With little hard news on the agenda, the press conference following
the ECB’s monthly monetary policy meeting will likely focus on
longer-term prospects, such as the possible willingness of the bank to
engage in quantitative easing or to offer additional non-standard
support.
Although Eurosystem policymakers have indicated that they do not
necessarily consider the current record low refinancing rate of 1% to be
a floor, it is too early to expect yet another rate cut this month.
Risks to the inflation outlook are still seen as “broadly
balanced,” and the cut in December already faced significant resistance
on the Council. Central bankers will likely have to see more signs of
economic weakness before pushing rates to a new record low.
Since the last meeting, there have been some signs that the
economic slowdown is decelerating. The recent sharp depreciation of the
euro, if sustained, could further accentuate that trend.
Still, with the negative feedback loop between the debt crisis and
the real economy far from broken, circumstances could change quickly.
The big question is how far the ECB might go should deflation risks
emerge. Where does it see the floor for its main refi rate and what will
it do once that level is hit?
ECB President Mario Draghi will certainly be pressed on a possible
new rate floor. He will also be questioned on whether he shares the
opinion of former ECB Executive Board member Lorenzo Bini Smaghi, who
said late last year, just before he stepped down, that there are no
obstacles to QE in the Eurozone should economic conditions require it.
In his last interview in office, Bini Smaghi said he “would see no
reason why such an instrument [QE], tailor-made for the specific
characteristics of the euro area, should not be used.”
While Draghi is unlikely to slam the door on QE, expectations that
such a policy would take the form of massive unsterilized government
bond buys — thereby killing two birds with one stone by also bringing
down borrowing costs for troubled peripheral countries — may be
misplaced.
Quantitative easing tailored for the Eurozone, where the banking
system is a far bigger source of credit than in the U.S. or the U.K.,
could also take the form of larger-scale covered bond purchases, or
purchases of unsecured bank debt securities.
Such measures would certainly be in line with the ECB’s heavy focus
on supporting the European banking system, and they could even be
considered in the absence of severe deflationary risks should massive
liquidity injections via the three-year refinancing operations not have
the desired effect.
The ECB injected a record E489 billion in three-year loans into
Eurozone banks in December, hoping that would encourage them to increase
lending to the real economy, to each other, and potentially even to use
the additional cheap cash to buy much higher-yielding government bonds.
Until now, not much of that has been happening. Banks are still
parking most of the funds back in the ECB. The overnight deposit
facility hit a new record high of around E482 billion on Tuesday, only
the latest in a string of days on which the deposits were well above
E400 billion. In the face of persistent debt market tensions and heavy
bond redemptions in the first months of the year, the banks have thus
far opted to hoard liquidity.
ECB policymakers, however, expect the positive effects of their new
liquidity operations to take some time to filter through. It is still
early days and probably premature to assess whether the ECB’s plans will
pan out. Draghi will likely refrain from drawing any definitive
conclusions this Thursday.
Before launching any additional liquidity measures, the Governing
Council will almost certainly want to monitor more extensively the
impact of the liquidity injections and await the second three-year
tender on February 28, when the full reform of collateral rules should
also be in place.
Draghi is also unlikely to offer any new insights into the ECB’s
government bond purchases, known as the Securities Market Programme.
Instead, he can be expected to repeat that the program is limited in
both scope and size and to pressure governments to intensify their own
efforts to rein in the crisis.
Preventing an uncontrolled Greek default and avoiding the fresh
contagion that would surely follow must be part of those efforts. German
Chancellor Angela Merkel and French President Nicolas Sarkozy warned on
Monday that Greece would not receive its next installment of aid money
until negotiations with private sector creditors — for a haircut of at
least 50% on Greek bonds — are concluded.
Draghi may not go as far as Council member Athanasios Orphanides,
who recently urged that plans for a haircut on privately held Greek
bonds be dropped. But the ECB chief will certainly not take pressure off
governments by signalling that the central bank would be ready to step
in with more aggressive bond buys to deal with the fallout from a
possible default by Athens.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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