By Johanna Treeck
FRANKFURT (MNI) – Given the European Central Bank’s U-turn on
collateral rules, Thursday’s press conference is likely to focus on the
details of the new framework and its implication for the central bank’s
credibility.
Near-term monetary policy considerations should play second fiddle.
President Jean-Claude Trichet’s assessment of the macroeconomic
environment should remain largely unchanged, making current interest
rates still “appropriate.”
After the limited demand for liquidity at the ECB’s final 6-month
refinancing operation, Trichet is also likely to confirm that the ECB’s
exit from non-conventional measures remains on track, although the
covered bond program could be an exception.
The ECB’s announcement that it will continue accepting BBB-rated
securities in its refinancing operations after year-end is widely
perceived as retreat from previous declarations by Trichet that “we will
not change our collateral framework for the sake of any particular
country.”
Greek bonds were the only government securities facing a realistic
risk of being excluded from ECB refis had the ECB returned to the old
framework as planned at the start of 2011. For a central bank priding
itself on predictability, only the perception of a strong risk could
have prompted it to abandon its previous commitment.
Likely assurances from Trichet that new collateral rules are not
aimed exclusively at assisting Greece, won’t mute journalists questions
on what this decision means for ECB policy in the future. If push comes
to shove, will the ECB help individual countries by keeping interest
rates down even at the risk of endangering price stability? Is a common
monetary policy still feasible?
The ECB is facing a real credibility challenge and Trichet will be
hard-pressed to dispel the concerns.
Markets will also closely watch the precise details of collateral
rules to assess refinancing costs ahead.
Currently, the ECB determines haircuts on eligible securities by
the asset class (based on liquidity), residual maturity, and the coupon
type. The ECB also applies an add-on haircut of 5% to all paper rated
below A-.
Trichet announced late last month that in the future the ECB will
also have a “graded haircut schedule,” which is widely expected to
include a fourth criterion based on an asset’s rating. No precise
details are available as yet, but they are expected be announced after
the ECB’s Thursday meeting.
Banks will look out for a potential reduction in current haircuts
to partially offset new rating-based haircuts. They will scrutinize the
impact of the new system on debt and other securities below the AAA
level.
For the sake of simplicity, the ECB may introduce only a limited
number of steps, applying the first ratings-based haircut at the current
A- level. This would ensure that assets that were eligible without
add-on haircuts in the pre-crisis regime would remain unaffected, and it
wouldn’t weigh on banks’ refinancing abilities.
Another option would be to introduce a sliding scale starting at
anything below AAA. The ECB could partially offset the rising cost based
on ratings by reducing other haircuts.
Still, this system would adversely affect government bonds of a
number of countries, including those of Italy, Portugal, Ireland,
Belgium, thus risking aggravating the crisis. The sovereign debt
securities of those countries are currently all rated above A-, and thus
they are not subject to any ratings-based haircuts at present.
The beauty of a sliding approach, however, is that it would allow
for stronger communication aimed at backing the central bank’s
credibility. The ECB might argue that rather than being intended to
support Greece, the new collateral framework will help ensure much
needed fiscal discipline by incrementally reducing the attraction of
bonds below top rating.
The new graduated framework, though keeping Greece in the picture
beyond 2010, will almost certainly make it more expensive for Greek
banks to finance themselves next year.
Trichet will no doubt also be quizzed on the ECB’s assessment of
the rescue deal for Greece agreed by EU leaders last month and on latest
reports that the Greek government is seeking to amend the deal to bypass
a financial contribution from the IMF, which it fears would be
accompanied by unpalatably stringent conditions.
After previously rejecting IMF involvement ahead of the agreement,
Trichet is unlikely to embrace the deal without reservations, but he
could assume a practical approach similar to that of Lorenzo Bini
Smaghi, who said that “sometimes the second best solution is the most
realistic. We have to make it work.” Trichet should also reiterate that
any IMF involvement must leave the ECB’s independence unscathed.
Nevertheless, Trichet is likely to repeat that he welcomes the fact
leaders have agreed on a deal, and he almost certainly will not be drawn
into speculation about potential changes to the agreement.
Looking at the macroeconomic environment, March’s unexpected spike
in consumer price inflation should not significantly change the
Governing Council’s assessment just yet.
While March Eurozone HICP came in much higher than expected at 1.5%
y/y, Trichet is likely to confirm “low inflationary pressures in the
medium term.” At the same time, recent data will reinforce that
assessment that the “recovery in the euro area is on track, although it
is likely to remain uneven.” Interest rates should thus remain firmly on
hold.
Trichet should welcome the limited uptake of final six month loans
as a sign of ongoing improvement in the banking sector, justifying the
ECB’s gradual withdrawal of liquidity support measures. The president
should thus confirm that the central bank will proceed with its exit
strategy as planned.
He may also announce the maximum allotment amount for the first
3-month tender since the crisis measures were introduced to be conducted
with the traditional fixed allotment, variable rate procedure. While the
result for the 6-month tender heralds limited uptake, the ECB should
offer a generous amount to reassure markets that it is committed to
“smooth out the liquidity effect.”
Journalists are also likely to probe Trichet on the central bank’s
plans for the covered bond purchase program amid ongoing fears that an
end to the program could hurt banks’ refinancing abilities. That ECB has
already completed three quarter of the E60 billion program and widened
it by allowing National Central Banks to voluntary lend out bonds
purchased under the program.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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