By Johanna Treeck

FRANKFURT (MNI) The ongoing economic recovery and abating
financial market tensions should allow European Central Bank President
Jean-Claude Trichet to strike a somewhat more optimistic tone during
what promises to be an uneventful press conference on Thursday.

The improvement appears to be substantial enough for the ECB to
resume its gradual exit from non-conventional policy measures, as
suggested by the significant slowdown in bond purchases and the central
bank’s announcement of tighter lending conditions via a new collateral
framework next year.

Nevertheless, Trichet should not be expected to commit to
additional unwinding of unconventional support measures or herald any
change in the ECB’s monetary policy stance in the months ahead.

The president is likely to describe the current refi rate of 1% as
“appropriate” and reiterate that rising money market rates are a
function of banks’ liquidity preferences, implying no monetary policy
signals. In fact, Governing Council member Jozef Makuch has assured that
“there is no reason for speculation regarding the rate increase until
2011.”

Hopes for similarly clear guidance on non-conventional measures are
likely to be disappointed, however, even though Trichet will certainly
be pressed on the issue.

While the controversial bond buying-program has virtually ground to
a halt at E60.5 billion, Trichet should not formally pronounce an end to
interventions. Council members have indicated they will keep the
facility open and remain ready to act if needed.

“As data show, the bond-buying program has been reduced to more or
less zero, but it makes sense to be in place as a security measure,”
Ewald Nowotny said.

As regards the liquidity framework, Trichet may limit his comments
to saying that “overall provision of liquidity will be adjusted as
appropriate.” With fixed-rate, full-allotment procedures for weekly
operation scheduled through October 4 and for three-month operations
through September 6, the Council can postpone any decisions until the
September 2 meeting, when it will have a better idea of what appears
“appropriate.”

The decision at that time should largely hinge on further easing of
financial market tensions. Recent trends in this respect have been
encouraging. Trichet may hightlight the falling demand for central bank
cash and declining use of the deposit facility.

Trichet should welcome the European bank stress tests as a positive
transparency exercise that showed that the Eurozone’s banking system is
fundamentally sound, while dismissing criticism that the testing
scenarios were too lax. The test results released on July 23 showed only
seven of 91 European banks falling short of The tier 1 capital ratio of
6%.

At the same time, Trichet can be expected to downplay results of
the ECBs second quarter bank lending survey which showed an unexpected
tightening of credit conditions and prospects of yet tougher standards
ahead.

Survey respondents largely ascribed tightening of credit standards
to the turmoil and uncertainty surrounding the sovereign debt crisis,
Trichet may point out. The recent stabilization of markets and in
particular the bank stress tests results should help dissipate
uncertainties and make banks more willing to lend, his argument may run.

Nevertheless, the ECB can be expected to tread very carefully in
removing support for the sector before lending has turned around. Any
moves may be further complicated by diverging developments across
countries. German banks, for instance, refrained from tightening lending
conditions to firms in 2Q and expect to become more generous in the 3Q.
By contrast, lending terms for Portuguese firms have almost returned to
the tight standards seen at the height of the crisis at the end of 2008.

Similar divergences have also been seen in broader economic trends,
tainting what have been surprisingly positive aggregate developments.

Recent data have come in better than expected, pointing to robust
Eurozone growth in 2Q. Largely shrugging off financial market turmoil,
key confidence indices have recovered, signaling further growth in 3Q,
which should allay fears of a double-dip recession.

For some countries, however, the data have been less encouraging.
The European Commission’s sentiment survey and PMI polls reveal a
widening gap between the Eurozone’s core economies and the periphery,
where private deleveraging and austerity measures are weighing on growth
and confidence.

The Commission’s July sentiment index rose to its highest level in
two years, but the Greek component remained exceptionally low and
Spain’s took a turn for the worse. The latest pick-up in Eurozone PMI
was almost exclusively driven by Germany.

Another cloud on the brightening horizon is the recent surge of the
euro-dollar rate, which recovered some 10% in six weeks to hit a
three-month high at $1.3261 on Tuesday. If the trend continues, the
competitive boost to the Eurozone’s export-lead recovery could wane at a
time when austerity measure will increasingly weigh on domestic demand.

While the overall tone of the press conference is likely to be more
upbeat, lingering concerns could lead the Council to confirm its
scenario for growth at a “moderate and still uneven pace, in an
environment of high uncertainty.”

Although inflation accelerated to 1.7% last month, the fastest pace
since November 2008, the increase was driven mainly by base effects and
value-added tax hikes in southern European countries. With core
inflation contained, price developments should continue to take a
backseat during Thursday’s conference.

Brightening economic prospects this summer should lighten pressure
on the ECB for action on the policy front. Still, as Trichet might say,
this is “no time for complacency,” since important deadlines for the
future liquidity framework are approaching fast.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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