FRANKFURT (MNI) – Some European Central Bank Governing Council
members this week dismissed inflation concerns raised recently by their
colleagues Juergen Stark and Axel Weber, and they were duly vindicated
by lower-than-expected Germany inflation data.
Meanwhile, a spike in three month LIBOR rates and results of the
first open market operation with competitive bidding suggest that the
central bank will have to proceed very carefully in withdrawing
remaining liquidity support.
Although harmonized consumer inflation bounced unexpectedly in the
Eurozone last month, Guy Quaden stressed in an interview with Market
News that this development was “starting from very low inflation
levels.” Moreover, prevailing HICP as well as “inflation expectations
remain at a level compatible with our definition of price stability,” he
noted.
During his parliamentary hearing, ECB Vice-President Lucas
Papademos similarly showed no concern about the upside inflation risks
that his German colleagues had spotted and Axel Weber reaffirmed last
Wednesday. Instead, Papademos highlighted that core inflation “has been
on a gradual downward trend since mind 2008.”
German inflation data, released Wednesday, suggests that this trend
in core inflation is continuing. Data surprised on the downside, as an
ongoing rise in commodity prices failed to offset a deceleration in core
prices. The headline inflation rate was +0.9% y/y (compared to a 1.2%
forecast and 1.1% in March), while details suggest that the trend in
core inflation remains yet more benign.
The latest inflation reading in the Eurozone’s largest economy
certainly does not suggest the need to lift interest rates any time
soon, and a number of Council members — including the inflation mongers
Stark and Weber — have confirmed that interest rates remain
“appropriate.”
The central bank may not only keep interest rates on hold but also
retain extra liquidity measures for some time to come as latest
developments suggest that money market conditions may be deteriorating
and credit is still not flowing freely to the private sector.
In the first 3-month refi operation under competitive procedures,
only 24 banks participated, taking up just under E5 billion of the
indicative offering amount of E15 billion. Those banks were ready to pay
a notable premium on ECB money, taking the weighted average rate to
1.15%, which suggests that some banks may still have limited market
access.
Interbank borrowing costs for 3-month loans also spiked to
O.59775%, up 1.03 basis points on the day. Traders said U.S. banks are
increasingly reluctant to fund their European counterparts after S&P
ratings agency announced late Tuesday a cut in Portugal’s sovereign debt
rating by 2 notches to A- and in Greece’s rating by 3 notches to BB+ —
dropping it below investment grade to “junk” status.
Wednesday’s S&P downgrade of Spain to AA from AA+, then, will
certainly do nothing to ease the concerns of the U.S. banks.
A failure to get the Greece crisis under control could put an
increasing number of European banks under pressure, limiting their
market access and making the ECB once again the main source for
liquidity provision as in earlier phases of the crisis.
The number of bidders in upcoming operation could thus be much
higher than at today’s auction, keeping supplemental liquidity
operations on the agenda for some time to come — or even forcing the
central bank to bring back measures it has already phased out.
A fresh liquidity crisis for Eurozone banks would be particularly
dangerous, since banks are still tightening lending conditions for both
enterprises and private households and plan further tightening in the
second quarter, the ECB’s Bank Lending Survey showed on Wednesday.
The ECB is “on a good path” for returning to the allotment
mechanism of refinancing that was “usual before the crisis,” Weber said
Wednesday.
However, Weber also warned that the impact of the crisis may not be
fully reflected in credit volumes yet. He thus called for a
“step-by-step withdrawal” of remaining liquidity support measures along
with a “continuous monitoring of financial market reaction” to such
withdrawal.
Given current volatility in financial markets, the ECB may still
tread more carefully than previously expected.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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