FRANKFURT (MNI) – The European Central Bank is gearing up for more
support measures to show that Europe is serious about addressing the
crisis, but expectations of a cut in the ECB’s key refinancing rate as
soon as next Thursday may be premature.

Policymakers are no doubt increasingly concerned about recent
developments in financial markets and a potential spillover into the
real economy, but at this point they seem likely to rely primarily on
liquidity measures to address the causes of recent tensions.

While a number of Council members, including Luc Coene, Yves Mersch
and Ewald Nowotny have allowed for the possibility of a reduction in
borrowing cost should the economy deteriorate further, others have
stressed that real rates are negative and borrowing costs thus very low.

Mersch outright rejected any speculation of a sharp 50 basis point
cut. “These wild expectations only show that some people have lost the
north,” he told Market News International, in a reference to the
often-cited ECB priced stability compass.

Even a more modest cut of 25 basis points may not be in the offing
before downside economic risks materialize further. Executive Board
member Lorenzo Bini Smaghi said Tuesday that we are still in a very
different position than when the ECB slashed interest rates to a
historic low of 1.0% in 2009.

That level “was calibrated for a very sharp recession and the risk
of some deflation, which [had] characterized the situation back in
2009,” Bini Smaghi told Markit magazine. “Compared with 2009, we are now
in a different situation.”

In an interview with MNI on Saturday, Council member Josef Bonnici
described borrowing costs as “extremely cheap” and noted that real
interest rates are negative. “More than interest rates…the provision
of liquidity and funds to the banking sector is probably of more
significance at this stage,” Bonnici said.

While a cut in the ECB’s key policy rate may not be on the cards,
there is little doubt that when Governing Council meets on October 6 it
will add to the ECB’s array of full-allotment refinancing operations.
“We need to reassure markets,” Bini Smaghi stressed Monday.

Mersch told MNI, “there are a certain number of possibilities and
options that are on the table” with regard to such non-standard
measures.

One likely option is the re-introduction of a fixed-rate one-year
tender with full allotment. A number of Council members, including Ewald
Nowotny and Jens Weidmann, have hinted at their support for bringing
back the 1-year LTRO, which was last offered in December 2009.

Calls for even longer maturities or for an ECB pledge to continue
offering full allotment refinancing operations indefinitely will likely
be disappointed. Bini Smaghi said Tuesday that such “unconditional
commitments are not credible.” Nowotny told MNI that in his view the ECB
should not further expand its toolkit.

Relying on tools that have already been used to boost liquidity,
another option would be for the ECB to resume its covered bond buy
program. Citing a euro area central bank official, Bloomberg said the
Governing Council will likely discuss new covered bond buys.

The ECB could of course also deploy its interest rate tool to help
keep liquidity in the system. A re-widening of the rate corridor by
cutting the deposit rate seems very plausible since it would discourage
banks from parking their money at the ECB.

A further exacerbation of market tensions in the run-up to the
Council meeting could still tip the balance in favor of more aggressive
action on interest rates next week.

Europe has to show its readiness to get a grip on this crisis and
the ECB may be the only institution able to send a clear signal in that
direction as the bailout fund reform and bank recapitalization efforts
of EMU political leaders remain painfully slow.

At this stage, however, a refi rate cut on Thursday appears to be
far from a done deal.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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