By Johanna Treeck

FRANKFURT (MNI) – European Central Bank President Jean-Claude
Trichet is banking on stress tests and government deficit cutting
efforts to allow the ECB to further unwind unconventional support

Amid improving market conditions, the ECB’s government bond
purchases may be slowing in the weeks ahead, and no additional longer
term refinancing operations are considered necessary at the current
juncture, Trichet said.

Interest rates, on the other hand, remain firmly on hold. The
recent rise in interbank lending rates should by no means be read as a
monetary policy signal, the ECB president emphasized.

“It would be a complete mistake to interpret what we are observing
on the market as a monetary policy signal. It is not the case at all,”
he said.

The combination of expiring and new refinancing operations —
including the reimbursement on July 1 of E442 billion in 1-year funds to
the ECB — have drained a net E244 billion from the system, pushing
main euribor rates earlier this week to their highest level in 10 months
and three-month rates to their highest since September.

Trichet did not sound worried about the higher borrowing costs,
suggesting that the central bank will tolerate some tightening of
monetary conditions through rising money market rates.

“It is the consequence of the decision of the banks themselves at
the moment of the renewal of their previous financing to ask for less
than they could have done,” Trichet noted. “If banks had asked for more,
probably we would have lower market rates.”

The president did not disclose whether the option of an additional
longer-term refi to keep rates lower had been discussed. Instead, he
reminded that “we have already decided to continue to proceed with the 3
month operation in an unlimited-supply-of-liquidity mode for a number of

A more optimistic sounding Trichet also signalled that the ECB may
continue to slow the pace of its controversial government bond buys.

“I think it is not untrue to observe that there is a tendency for
the secondary [sovereign debt] market to function perhaps a little bit
better,” Trichet asserted, noting that markets are beginning to take
into account a range of measures including government deficit cutting
measures and the creation of the E440 billion stability facility.

“You see the amount of these [sovereign bond purchasing]
operations, of this programme, and we have the feeling — but we will
continue to observe it with great attention — that what is needed in
terms of the level of interventions on our part has been progressively
diminishing,” Trichet said.

He did not seem to reject the possibility of future bond buys being
carried out by the stability fund rather than the ECB, a move that would
free the central bank of a task with which some of its most senior
policymakers are extremely uncomfortable.

“We will see exactly what will be the utilization of this
stabilization fund practically,” Trichet said. “I would call for
flexibility in the utilization of fund.”

Upcoming bank stress tests are among “the positive decisions that
have been taken” by governments and European institutions, Trichet said.
“We are…convinced that transparency has its virtue. It is good that
investors and savers can see exactly the results of those tests.” He
said he expected the testing to be “confidence building.”

However, Trichet failed to disclose specific details of the stress
tests or the ECB’s assessment of the scenarios to be tested.

In addition to a set of macroeconomic variables, “the exercise also
envisages adverse conditions in financial markets and a shock on the
interest rate to capture an increase in risk premiums linked to a
deterioration in the EU government bond markets,” Trichet said. “All
this will be made public when the time comes. At this stage, we have no
other communication.”

Pressed again on the issue, Trichet said that “the details of that
is in the hands of the [Committee of European Banking Supervisers
(CEBS)] and will be of course made public in due time.”

He also failed to confirm reports that governments running short of
funds to help with the recapitalization of troubled banks would be able
to draw on the European Financial Stability Facility.

Late Wednesday, the London-based CEBS — which is coordinating the
testing — released details of the methodology being used and named the
ninety-one banks being tested. Many analysts have already voiced concern
that scenarios tested for may not be tough enough.

Meanwhile, the Governing Council’s economic outlook presented in
the introductory statement remained largely unchanged and Trichet
dismissed growing fears of a double dip recession.

“I see perhaps a tendency not of ours, because we remain very
cautious and very prudent, but from outside, to perhaps be excessively
pessimistic about us. And I think that the figures that we have are not
confirming this pessimism,” he said.

The key to future unconventional policy moves by the ECB will be
whether the pessimistic view is borne out by the bank stress tests.

Tests that appear too soft and do not include a severe sovereign
debt shock, or a sketchy release of results, may throw the tentative
recovery into reverse, increasing fears over about might still be hidden
and raising doubts about Europe’s commitment to clean up its banking
system. Any failure for to provide immediate recapitalization for banks
in need could lead to a fresh seizing up of money markets, requiring the
ECB to make another U-turn on its exit strategy.

Details of the stress tests thus far known are not yet enough to
confirm the ECB’s new optimism.

–Frankfurt newsroom +49 69 72 01 42; Email:

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