By Johanna Treeck
FRANKFURT (MNI) – European Central Bank President Jean-Claude
Trichet will likely maintain his heightened anti-inflation rhetoric at
Thursday’s monthly press conference and may even sound more hawkish
should the results of the ECB Survey of Professional Forecasters suggest
a rise in inflation expectations.
However, there is little doubt that for now the central bank will
keep interest rates on hold with Trichet reiterating that they “still
remain appropriate.”
Expectations of how long “still” may be have shortened noticeably
since Trichet shook markets with hawkish tones last month. Markets are
now fully pricing in a 25 basis point rate hike by July as well as a 99%
chance of a second hike by December. At this time last month, markets
were not expecting tightening until early 2012.
Trichet has done nothing to correct the new expectations and as
recently as last week assured that he had “nothing to add” to last
month’s inflation message. Executive Board member Lorenzo Bini Smaghi
even appeared to step up inflation warnings from within the Eurotower.
Imported inflation should “no longer be ignored,” Bini Smaghi
warned. “A permanent and repeated increase in the prices of imported
products will tend to impact inflation in the advanced countries,
including the euro area,” he said.
Trichet is thus likely to repeat his anti-inflation rhetoric and
stress that the ECB is ready to hike interest rates if current headline
inflation — which hit a 27-month high of 2.4% in January — shows any
sign of leading to second round effects or raising medium-term inflation
expectations.
Trichet may even sound more hawkish should the results of the
Survey of Professional Forecasters show any evidence of rising
expectations. Results of the latest survey should be available to the
Council on Thursday.
For now, Trichet’s strong language should be read primarily as a
warning signal aimed at nipping in the bud any risk of second round
effects. In an interview with the Wall Street Journal, he appeared to
suggest that the ECB may yet weather the current spike in inflation
without raising interest rates.
“All central banks, in periods like this where you have inflation
threats that are coming from commodities, have to go through the hump
and be very careful that there are no second- round effects,” Trichet
said. “This is what we are doing,” he said, adding that “at this stage”
the ECB doesn’t see any second-round effects.”
Given the potentially destabilizing impact of a rate hike on
peripheral countries, weak banks and market confidence, clear signs of
rising domestic price pressures or higher medium-term inflation
expectations may be required to prompt a rate hike. Some Council
members, including Athanasios Orphanides and Ewald Nowotny, warned that
markets have overreacted to the ECB’s new language on inflation.
Still, the stronger-than-expected economic recovery and sharply
rising input prices, both reflected in January final manufacturing PMIs,
may justify the push forward in rate hike expectations, especially if
commodity price pressures persist. That is all the more true given the
recent warning by some very senior ECB officials that the central bank
may not rely too much on benign core inflation as an indicator of price
stability.
A convincing package of new measures by EU leaders, which would
dispel market doubts about the Eurozone’s viability and show that they
are both willing and able to bail out member states if necessary, could
also make it easier for the ECB to take early pre-emptive action.
A strong deal — especially a larger and more flexible European
Financial Stability Facility (EFSF) — may be even more immediately
relevant for the ECB’s non-standard measures going forward, both as
regards the bond buying program and the liquidy framework.
Trichet will likely reiterate the ECB’s support for increasing the
fund’s lending capacity and broadening its mandate — in particular,
allowing it to buy government bonds.
However, no decision on the bond purchase capacity — which is seen
as potentially violating the Maastricht Treaty and thus legally
difficult to push through — is likely until next month, though
negotiations on the issue appear to be far along.
Trichet will thus confirm that ECB bond buys are ongoing — even if
they ground to a halt last week — while keeping up the pressure on
fiscal authorities to take over that task. Indeed, the ECB’s decision to
abstain from the bond market last week for the first time since October
— in the week running up to the meeting of EU leaders on February 4 —
may well have been intended to send a message, though it’s also true
that the ebbing of tensions in the market meant the ECB’s presence was
not required.
Results of the deliberations among EU leaders may also effect the
ECB’s liquidity framework, since one option under consideration is to
allow the EFSF to provide short-term credit lines to banks — a move
that could reduce demand at the ECB’s refinancing operations.
Even in the absence of external support from governments, the ECB
is anxious to wind down its role as lender of last resort and return to
competitive bidding in its main refi operations, discouraging banks from
borrowing excessively from the ECB without cutting off the weakest
institutions entirely.
The basic concept under consideration is a two-tier liquidity
provision system. Each bank would be able to borrow up to a certain
amount at the ECB’s fixed-rate (1.0%) refinancing operations, with
limits differing from bank to bank. Those with cash needs above their
assigned ceiling would have to pay a higher rate for the extra money.
Another idea under discussion, is that in addition to charging a
higher rate in exchange for the extra cash, the ECB could also require
the banks in question to take concrete steps to boost their core
capital. However, this appears to be less likely due to technical and
legal complexities.
Eurosystem monetary sources said that planing has progressed well
but that no decision or announcement is imminent. As the ECB is under no
pressure to provide an update on its liquidity operations until March,
Trichet will likely promise to give more details at next month’s press
conference.
Progress of Eurozone leaders on reform and aid proposals, as well
as early signals from the new round of bank stress tests, will likely be
key to the decision at the time. With the more hawkish tone and
governments appearing more prepared than ever to bring lasting calm to
markets, chances are that the ECB may dare a new attempt to slowly
unwind liquidity support measures.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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