By Johanna Treeck
FRANKFURT (MNI) – The European Central Bank on Wednesday will
likely provide little relief to nervous markets or politicians
scrambling to reinforce the Eurozone’s institutional structures.
Even as the debt crisis reaches a new peak of intensity, with Spain
moving ever closer to a bailout, the ECB will likely continue its
dangerous stand-off with Eurozone governments by withholding any
additional accommodation for now. Draghi made clear in the European
Parliament last week that the ECB could not “fill the vacuum” created by
governments’ policy failures.
“The ECB should not be the easy way out,” one senior Eurosystem
official told MNI. “In order to continue, we must see a solid effort
from the governments, and we expect to see a detailed plan at the summit
on June 28-29. Only then would we determine our stance.”
Holding his press conference on Wednesday, a day earlier than usual
due to a public holiday in Germany where the ECB is headquartered,
Draghi will likely signal the most flexibility on interest rates, since
this is seen a firmly within the realm of the central bank’s
responsibility.
Easing inflationary pressure and weakening growth will no doubt
push the prospect of an interest rate cut back onto the agenda. There
may well be voices calling for a move as soon as Wednesday’s monetary
policy meeting, but chances are that central bank will keep a steady
hand for now.
The dismal economic data since the last policy meeting in May is
likely to have shaken the Council’s confidence that economic activity
will “recover gradually over the course of the year,” leading Draghi to
strike a more dovish tone. The ECB staff forecast for 2012 Eurozone
growth, due to be published Wednesday, will likely also see a downward
revision.
May’s PMI showed Eurozone business activity contracting at its
steepest rate in nearly three years. Even Germany, the Eurozone’s growth
motor, is sputtering. According to the most recent purchasing managers’
index (PMI), activity in Germany slid for the first time in six months,
while the IFO business sentiment indicator dropped sharply. Meanwhile,
Eurozone unemployment hit a record of 11% in April.
On balance, the Governing Council will likely keep rates on hold
for another month. Just before his eight-year term as an Executive Board
member expired last week, Jose Manuel Gonzalez-Paramo said, “we still
share the view that the modest recovery is the baseline scenario.” The
sharp drop of the euro may offer some much needed stimulus in that
direction.
The ECB will probably also want to retain the small amount of
maneuvering room it still has given the potential for considerable
additional turmoil following national elections in Greece on June 17.
Should Greece end up exiting the euro area and panic ensue, the central
bank would need the maximum possible monetary firepower.
In terms of actual announcements, the Council will no doubt extend
the fixed-rate, full allotment procedure for their regular three-month
and weekly refinancing operations. But it should not be expected to
signal another 3-year operation in the near-term. “Clearly this is not
on the cards. At this moment there is no liquidity problem so there is
no need for another LTRO,” Council member Ignazio Visco told the
Financial Times on Thursday.
Another central bank source told MNI, “we have done our part on
liquidity. We are hindered by our mandate from doing more.”
In a similar vein, Council member Ewald Nowotny said last week that
a reactivation of the bond buying program for “the time being is not a
matter of discussion.” While Draghi may reiterate that the program is
ongoing, the ECB’s absence from the market as Spanish yields spiral
speaks volumes of the central bank’s lack of desire to restart the
program.
Draghi has gone out of his way not only to put the ball in
governments’ court but to stress the impotence of ECB action unless
governments do their part. The bank’s interventions have failed to exert
their full impact due to inadequate government policies, he said.
Current adjustment efforts must be coupled with a 10-year vision of
further European integration, starting with a “banking union” to restore
trust in the Eurozone, Draghi said. To push governments into action, the
ECB in the meantime is ready to take the Eurozone one-step closer to the
brink. The approach appears to be showing some signs of success for now.
With the ECB staying on the sidelines for now and top financial
officials, including Ignazio Visco, warning that the Eurozone might
disintegrate in the absence of quick reform, fiscal policy-makers are
scrambling to accelerate plans for a banking union. Meanwhile, Spanish
Prime Minister Mariano Rajoy has made a complete U-turn from asserting
national sovereignty on budget policy earlier this year, by calling for
a European fiscal authority.
Still, the ECB may not be able to play this game of brinkmanship
for much longer. It appears impossible that a banking union with a joint
deposit guarantee scheme could be set up in time to prevent a
much-feared bank run in peripheral Europe should Greece exit. Nor would
it be likely to prevent deposit outflows unless it explicitly covers
redenomination risks as well, which may not be politically feasible.
Another well-placed central banker sought to dampen some of the
recent expectations about quick banking integration. “It will happen,
but it’s something for the future. It will take a long time to plan and
enact,” he said.
ECB liquidity support for the periphery may well remain the first
line of defense. We may not have seen the peak of the liquidity flood be
it via long-term tenders or emergency liquidity assistance from national
central banks. Fresh bond buys should also not be excluded should the
situation deteriorate further. The pressure on the ECB is no doubt
rising.
Fresh escalation of the crisis may yet push the ECB back to the
front line of Europe’s fight against the crisis, but it looks unlikely
to launch a quick strike on Wednesday.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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