–Negative Rates, Decentralized Policy Key Question For 2013

By Johanna Treeck

FRANKFURT (MNI) – After a year in which it injected E1 trillion in
three year loans, slashed interest rates to a historic low of 0.75% and
announced possibly unlimited purchases of sovereign bonds, the European
Central Bank (ECB) is likely to end 2012 on quiet note.

Still, with key new staff projections likely to show very weak
growth over the forecasts horizon, the ECB will surely keep options for
further easing measures open and may have to break more new ground next
year.

But recent signs of economic stabilization following a string of
weak economic data should tip the balance on the Governing Council in
favor of keeping rates on hold in December.

While a weaker than expected economic outlook since September may
spark a downward revision of ECB staff forecasts for 2013 growth, it
does not appear to have changed the central bank’s broader scenario of a
slow recovery next year. “The recovery for most of the Eurozone will
certainly begin in the second half of 2013,” ECB President Mario Draghi
said last week.

The Governing Council will likely welcome the chance to postpone a
possible rate cut in order to keep its limited powder dry.

This is all the more true since the ECB appears undecided on how to
proceed should it eventually decide to cut interest rates. Should it opt
for a simple cut in the main refinancing rate, which may have a very
limited impact, or should it accompany a refi cut with the more radical
step of pushing the deposit rate into negative territory?

Draghi said last month that the Council had not discussed “matters
related” to a negative deposit rate. On Monday, Governing Council member
Christian Noyer said a negative deposit rate was “not excluded in
principle” but wasn’t “the major issue for the moment.” His colleague
Ardo Hansson told MNI that negative rates still require more study.

Any concrete announcements this Thursday could thus be limited to
new staff forecasts and a likely six-month extension of the fixed rate,
full allotment procedures for the weekly and the longer term refinancing
operations. The ECB’s existing commitment to maintaining them expires on
January 15.

Yet with fresh staff forecasts likely to show very weak growth
ahead, Draghi can be expected to keep the door wide open for further
support measures.

In defining those support measures, the ECB next year might have to
enter more uncharted waters and answer the key question of how much
common monetary policy a currency union needs.

Especially in the case of widespread economic weakness, including
the Eurozone’s core, the Governing Council might eventually have to cut
interest rates and decide whether to proceed with an unprecedented
negative Eurozone deposit rate.

However, it is not a given that additional easing would come via
the traditional interest rate lever. Council members stress that the
monetary transmission mechanism remains impaired, limiting the impact of
a rate cut on Eurozone economies that require stimulus the most.

Should progress on the planned banking union and a possible
activation of the ECB’s new bond buying program fail to reduce the
differences in credit costs for Eurozone companies, the central bank may
opt for a more targeted approach aimed at easing credit conditions in
the periphery via broader collateral rules.

Draghi repeatedly stressed that the widely divergent credit
conditions for Eurozone firms are unjustified. Especially for SMEs that
do not have access to the capital markets, credit conditions that are
implicitly tied to government refinancing costs because of domestic bank
holdings of risky sovereign debt, pose credit constraints that must be
addressed, Executive Board member Peter Praet said last week.
Securitizing SME loans for use as collateral in ECB liquidity operations
may be one way to ease their access to funding, he added.

In February, the ECB approved the temporary acceptance by national
central banks of additional credit claims, primarily bank loans, as
collateral in ECB funding operations, allowing banks easier access to
ECB liquidity in order to pass it on to their respective economies.

Critical voices described the ECB’s move as a “balkanization” of
monetary policy that – in the worst case scenario – could herald the end
of a common monetary policy that is the foundation for the currency
union.

Internally, too, there were concerns. “Such a decentralized form of
money creation is not a viable way forward,” Council member Yves Mersch,
who will join the ECB Executive Board later this month, warned in
October. “These measures must be monitored closely even if they are
subject to strict criteria, controls and volume limitation,” he
asserted.

However, given the wide fragmentation of Eurozone financial market
conditions, offering varying degrees of support depending on local
conditions may be seen as the most effective way to keep the union
together.

Executive Board member Benoit Coeure stressed Saturday that
“financial cohesion” is one “pre-condition for the treaty objective of
price stability,” for which the ECB is held accountable. Extending
additional support to specific regions could be justified by the ECB’s
current policy argument that the central bank must ensure its monetary
policy stance is transmitted where markets fail to do so.

Should the ECB decide to launch more ultra-long liquidity
operations, it would probably only do so after revising collateral rules
– either for the currency union as a whole or for particular national
central banks – to ensure that the relevant institutions in the
periphery have sufficient means to tap the operation.

— Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@mni-news.com

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