By Johanna Treeck
FRANKFURT (MNI) – The main focus of the European Central Bank’s
monthly press conference Thursday will be the health of the banking
system, with upcoming stress tests and future liquidity provisions
overshadowing traditional monetary policy issues.
ECB President Jean-Claude Trichet is expected to release a new
collateral framework for securities other than ABS and government bonds
and should again be quizzed on the central bank’s government bond buys.
The Governing Council’s assessment of Eurozone growth and inflation
prospects will likely remain largely unchanged, leaving current interest
rates “appropriate.”
While market fears of a double-dip recession have risen after
recent survey data suggested that the growth momentum has peaked, the
ECB has long projected a slowdown in the second half. The Council will
eye the pace of deceleration in the weeks ahead before reassessing its
position.
June’s slowdown in the annual HICP rate to 1.4% from 1.6% confirmed
that the previous pick-up in inflation was driven by largely oil prices
and that domestic price pressures remain subdued.
Nevertheless, the president should once again stress ongoing risks
in “an environment of unusually high uncertainty.”
Attention should then turn to the state of the Eurozone’s banking
system, liquidity provisions ahead and details on the upcoming stress
tests.
Trichet is likely to welcome the smaller than expected rollover of
the E442 billion in expiring one-year loans — half of outstanding ECB
loans to financial institutions — as an encouraging sign. Banks sought
to replace only E243 billion of that amount in three-month and six-day
operations conducted by the central bank. Since then, excess liquidity
has abated further.
The lower take-up, however, might also represent a growing divide
between healthy and troubled banks. With positive arbitrage
opportunities of locking in cheaper interest rates now removed and banks
having to pay an opportunity cost of 75 bps for leaving surplus funds at
the deposit facility, bids in the latest rounds are likely to have come
only from banks in genuine financial need.
To ensure sufficient liquidity supply to troubled banks and to
avoid undermining the fragile recovery by a rise in market rates as a
result of less and shorter-term liquidity — pushing main euribor rates
to the highest level in 10 months and three-month rates to the highest
level since September — the ECB might launch an additional longer-term
refi this Thursday.
The risk of fresh tensions emerging after the release of European
stress tests may also argue for another six-month tender, allowing banks
to stock up provisions ahead of potential freeze-up in interbank
lending.
On the other hand, the ECB might be reluctant to reverse what might
be a successful step towards an exit from its extraordinary liquidity
framework and limit its support to verbal assurance that the central
bank stands ready to inject fresh liquidity if and when needed.
This will largely depend on the outcome of the bank stress tests.
Optimists hope the results will improve confidence in the European
banking system, while pessimists fear they may spark fresh tension.
Caving in to pressure from the ECB, national regulators agreed to
extend the tests from 25 to around 100 banks, including Germany’s
Landesbanken and Spain’s cajas, which are suspected to have serious
balance sheets weaknesses.
The specific scenarios to be tested and the extent to which results
will be released are still under discussion. Final results are scheduled
to be published on July 23. Journalists will press for details of what
will be tested, what will be released and how potential capitalization
gaps will be addressed.
Tough and fully transparent stress test and governments ready to
bridge recapitalization needs could have a cathartic effect on money
markets similar to the one seen following U.S. stress tests last year.
On the other hand, tests that appear too soft and do not include a
severe sovereign debt shock or a sketchy release of results may have the
opposite effect, increasing fears over what might still be hidden and
raising doubts over Europe’s commitment to clean up its banking system.
Governments have assured that they are ready to meet their banks’
recapitalization needs. EU Monetary Affairs Commissioner Olli Rehn said
countries short of cash will be able to access the EU’s emergency loan
facility set up in May to support countries with sovereign debt problems
should they be cut off the market.
Heavy recapitalization needs would add to the debt burden of
governments, risking to exacerbate the sovereign debt crisis. Lengthy
procedures to tap emergency loans would only add to uncertainty.
Regarding the public bond-buying program, MNI has learned from
senior sources that there is a still a division on the Council, with the
German contingent pushing to close it down by the end of this year. The
ECB’s money market contact group, however, warned during their last
encounter with the central bank in late May that a return of liquidity
in the segment would take “quite some time.”
Trichet will keep cards close to his chest, dodging all questions
on the future of the program or details on the nature of the E59 billion
in bond purchased thus far.
As pre-announced in April, the ECB will also release details of its
new collateral framework for 2011. New rules will apply to securities
other than ABS and government bonds rated below A- and replace the
current 5% add-on haircut with a graduated scale depending on a
securities maturity and liquidity.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
[TOPICS: MT$$$$,M$$EC$,M$X$$$,M$$CR$,MGX$$$]
