By Johanna Treeck
FRANKFURT (MNI) – European Central Bank Jean-Claude Trichet on
Thursday will be challenged to defend the central bank’s latest
collateral move for Greece and explain its implications for future ECB
action.
The decision has raised doubts about the ECB’s credibility and
questions over how far the central bank may be willing to go and at what
cost.
Interest rates — at 1% for a year now — appear to be the most
stable element in the ECB’s universe and are set to remain that way for
some time. Trichet should confirm that rates are “appropriate” and no
change is generally expected before the first quarter of 2011.
The language of the introductory statement regarding the outlook
for the economy and inflation should also remain largely unchanged. Even
if there are budding inflation concerns, as voiced by the Council’s
super hawks Axel Weber and Juergen Stark, Trichet can be expected to
reiterate that risks are “broadly balanced.”
Inflation levels remain benign and the ECB will want to refrain
from spooking markets with fear of an earlier rate hike at this
juncture.
Future non-standard measures, on the other hand, are increasingly
hard to predict since the central bank has not only reversed course
repeatedly now, but also appears to have abandoned some of its core
principles.
Monday’s decision to accept Greek government bonds at its refi
operations regardless of their credit rating removed all pretence that
the ECB does not bend the rules “for the sake of any particular
country,” as Trichet insisted back in January. It also exposes the ECB’s
balance sheet to unprecedented and arguably unwarranted risks.
The decision quickly raised the question whether the ECB is ready
to abandon further principles and start buying government bonds should
market tensions persist or contagion risks intensify.
Senior Eurosystem sources told Market News that government bond
buys are currently not under discussion. “There was no discussion about
purchasing sovereign bonds and we should not start talking about this
possibility, because the Greek case is special,” one official said.
Another concurred that bond purchases “would be “difficult to envisage
now.” But he was also able to articulate the circumstances in which that
could conceivably change.
A government bond purchase programme would indeed break all taboos
since, in the current economic environment, it could hardly be
interpreted as anything less than a direct monetization of the fiscal
deficits.
However, the ECB has now proven that it is ready to break taboos if
it believes that doing so serves the greater good.
Removing collateral requirements — and forgoing margin calls on
the devalued Greek securities parked at the ECB, as a senior Eurosystem
source suggested to Market News International — would have been
unthinkable just a few months ago and could also be interpreted as
accommodating fiscal deficits.
When asked on Sunday about potential quantitative easing plans,
President Jean-Claude Trichet said that the ECB has no such plans “at
this stage.” Even Juergen Stark limited his rejection of bond buys to
“at present.”
In the absence of severe contagion risks from Greece the ECB
appears unlikely to opt for such a drastic measure, but the central bank
does not seem to be ruling out any options anymore.
Turning to extra liquidity measures, low participation in the
latest three-month tender suggests that fewer and fewer banks are
depended on ECB liquidity. The ECB’s previous assurance that liquidity
measures “have been introduced for systemic purposes and not to address
problems at individual institutions” suggests that the central bank can
press ahead with liquidity withdrawal after October.
However, rising Libor rates even since the Greek bailout decision
less than a week ago have highlighted how quickly money market tensions
can re-emerge, and a special rule for Greece raises questions about
special rules for banking institutions.
No decisions on the extra liquidity operations are pending before
October and any predictions of what might happen beyond that time are
little more than guess work.
Trichet will have the opportunity to remove some of these
uncertainties on Thursday. The central bank owes credible explanations
for its u-turn on Greek collateral.
The decision to accept Greek bonds even if they are rated junk
would be warranted if the bailout program failed or if further
downgrades were expected in spite of improvements.
Trichet is unlikely to publicly voice any doubts over the program,
which he himself said is “fully in line with what we wanted.” Instead he
may say the collateral decision is aimed at freeing Greece from the
negative impact of faulty rating agencies. This argument, however, does
not explain why a special case has been made for Greece.
A more convincing take would be to argue that dropping collateral
requirements will allow Greece to return to the market as early as
possible. By ensuring ongoing convertibility into ECB liquidity, the
central bank creates a safety bubble for Greek securities, making them
more attractive to Greek banks — and non-Greek ones, for that matter —
thus heightening the chances that not all the bailout funds will be
needed.
“We have viewed the Greek situation as a whole and decided that in
order to recover and regain the markets’ trust, Greece should first be
protected from market behavior,” one senior Eurosystem official
explained. Another senior official told MNI: “If you ask me, it was also
a clear message to the IMF of who is in charge.”
President Trichet will need to come up with a more convincing way
of explaining his dramatic about-face. It is not the ECB’s place to be
in charge of fiscal bailouts. In fact, that’s a mission that would seem
destined to conflict with the central bank’s central mandate and
justifiably raises concerns over its commitment to place price stability
over all else.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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