By Johanna Treeck
FRANKFURT (MNI) – The European Central Bank is likely to announce
Thursday that it will carry over generous liquidity provisions at least
into early 2011 while keeping interest rates firmly on hold.
Facing fresh headwinds from the global slowdown, President
Jean-Claude Trichet will maintain a cautious tone on the overall
economic outlook despite an almost certain sizable upward revision to
the ECB staff forecast for 2010 GDP.
Governing Council member Axel Weber last month essentially
pre-announced that the central bank would extend the fixed-rate
full-allotment terms on its open market operations, leaving little room
for surprises at the upcoming ECB press conference.
“As we go forward, I think there are good arguments to wait with
the normalization,” Weber said. He specifically ruled out changing the
full allotment policy for October’s 3-month tender. Coming from one of
its most hawkish members, these comments likely reflect broad support on
the Governing Council for continued accommodation.
Weber cited the need to smooth the typical “end-of-year tensions”
in money markets as the key reason for maintaining the fixed-rate
full-allotment procedure into next year. The expiry of some E225 billion
in ECB loans in September will present an additional hurdle for money
markets in the weeks ahead.
In the face of the exceptional challenge, Weber said that “most of
these discussions about the continuation of the exit I think will be
focused on the first quarter.”
The ECB can thus be expected to announce that it will stick to the
fixed-rate full- allotment procedure for its weekly operations as long
as needed, and at least until January. It will also likely offer some
additional three months operations under the same conditions.
Weber’s promise for a big debate on the exit in the first quarter,
however, might prove to be little more than wishful thinking. Trichet —
likely to have been annoyed by Weber’s pre-announcements — will
certainly not commit just yet to any such a debate or measures beyond
year-end.
Eurozone money markets still face bigger and longer-term challenges
than those cited by Weber.
“There is simply still too much dependency on ECB liquidity from
banks in the periphery. Right now it seems premature to make any firm
commitments given the uncertainty of the situation,” a Eurosystem source
told Market News.
Another Eurosystem source said that “as long as long as inflation
stay lows — and predictions still suggest that is the case — there is
no need to do anything more than a symbolic [exit] measure.”
After severe turmoil in the periphery forced the ECB to make a
U-turn earlier this year on plans to withdraw non-standard measures, the
central bank is likely to tread very carefully in withdrawing support as
long as some banks in those countries remain cut-off from interbank
lending — even as overall conditions continue to improve.
The president can be expected to remain similarly non-committal
about the scope of future bond buys aimed at supporting debt-troubled
periphery. Recent interventions, however, suggest that the central bank
will aim to keep a tight lid on those purchases.
Despite a significant recent re-widening of sovereign spreads,
sparked by higher-than-expected cost related to Ireland’s bank bail-out,
the ECB has not gone on a shopping spree. Irish spreads over German
Bunds were back at peak crisis levels seen in May, but the ECB bought
only E480 million only over the last two weeks compared to E16.5 billion
acquired during the first week of the program.
Still, there is little doubt the ECB will keep the facility open
and that it will not shy away from using it when it deems necessary.
The return of sovereign debt worries as well as increasingly
disconcerting developments abroad should prompt the Council to maintain
a cautious assessment of the economic outlook when drawing up Trichet’s
introductory statement.
True, the Eurozone’s recovery thus far has surprised everyone on
the upside. Following a much stronger-than-expected second quarter
growth rate of 1% q/q, the ECB staff forecast for 2010 GDP will almost
certainly be revised upwards from the current mid-point of 1%. One year
ago, the ECB staff had expected 2010 growth to be almost stagnant at
0.2%.
Moreover, the European Commission’s latest Eurozone economic
sentiment survey, released Monday, signaled no slowdown in the
near-term. After rising above its long-term average in July, the index
hit a 29-month high in August as industry and consumers expressed more
optimism about the economic outlook.
Nevertheless, there are rising and justifiable concerns that it is
only a matter of time before the Eurozone’s recovery takes hit. Europe’s
business cycle typically lags that of the United States, and the
downwardly revised U.S. outlook certainly does not bode well for
Eurozone growth ahead.
A cooling global economy, coupled with a decline in the positive
effects of the inventory cycle and a growing negative impact from
austerity measures, may become a significant drag on the recovery —
especially in peripheral countries that are still in or flirting with
recession. That could further exacerbate the troubling trend of a
two-speed recovery in Europe.
The ECB staff is thus likely to take a cautious stance on growth
going forward and should leave projections for 2011 GDP largely
unchanged from the mid-point forecast of 1.2% growth published in June.
Inflation forecasts for 2010 and 2011 are also likely to remain largely
unchanged at their current 1.5% and 1.6% levels, signaling no
inflationary pressures ahead.
Trichet should thus continue to describe the ECB’s current 1%
refinancing rate as “appropriate” and it should remain at its record
low, alongside non-conventional liquidity measures, for many more
months.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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