ECB Preview

by CC December 7, 2011 1:17 pm • Commentary

As everyone waits on the big EU Summit on Friday, the ECB will make their presence known in a meeting tomorrow morning. From Bloomberg:

The European Central Bank may announce a range of measures tomorrow to stimulate bank lending, said three euro-area officials with knowledge of policy makers’ deliberations.

Options on the table include loosening collateral criteria so that institutions have more access to cheap ECB cash and offering them longer-term loans to grease the flow of credit to the economy, said the officials, who spoke on condition of anonymity because the discussions are private. Two said an interest rate cut is likely, with only the size of the reduction to be determined for the monthly decision tomorrow.

The ECB is focusing on getting banks lending again rather than increasing its government bond purchases to fight Europe’s debt crisis. The central bank’s insistence that governments take measures to restore investor confidence appears to have paid dividends, with Italian and Spanish yields plunging after Germany and France agreed to move the 17-nation euro area toward a fiscal union, a stance they reiterated today.

“The ECB’s role tomorrow is going to be pretty much about the banks, and after tomorrow the liquidity side should be on a much stronger footing,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. “The division of labor is very clear — the ECB takes care of the banks, and the sovereigns take care of the fiscal side.”

Morgan Stanley put out a preview of the meeting this morning, here’s the lowdown:

We expect the ECB to lower rates again at its December meeting. While our base case is for a 25 bp cut, we would not rule out a larger move of 50 bp either. The ECB will also update its staff projections for 2012 and for the first time will present its projections for 2013. For 2012, we expect the staff to make a significant downward revision from the 1.3% for GDP growth and 1.7% for HICP inflation. Our best guess is that the ECB staff come out with estimates similar to the European Commission’s and hence will remain more optimistic than ours (see Recession Returns, November 28, 2011). Given that the ECB Governing Council was already expecting a mild recession last month when they cut 25 bp, we think that on balance they might not have enough ammunition to get a broad consensus on a 50 bp move at the December 8 meeting. Hence, we would only attach a subjective 40% chance to such a move, compared to 60% for the base case.

In terms of the tone at the press conference, the key focus will likely be on the ECB’s assessment of the risks to price stability.  At the last press conference, Mario Draghi’s debut as ECB President, inflation was seen as remaining “in line with price stability over the policy-relevant horizon” taking into account the 25 bp rate cut at that meeting. Especially for market expectations with respect to further ECB monetary policy stimulus in early 2012, the assessment of the inflation outlook will be key. The strongest possible hint at further ECB action in the near term would be to explicitly refer to downside risks to price stability (even after Thursday’s expected move) in the introductory paragraph. A more subtle way would be to talk about potential downside risks to the inflation forecasts further down in the introductory statement. Finally, concerns about a bank deleveraging and a resulting credit crunch could be factored into the assessment of monetary developments – if the Governing Council was indeed worried about this.

Beyond traditional monetary policy stimulus, the ECB could also decide to provide additional support for the euro area banks and in our view is likely to do so. These additional liquidity support measures could include additional and longer-dated LTROs with maturities of two or three years, a broadening of the collateral pool (possibly by lifting the limits on bonds issued for own use) and extending bank bond buying. We do see a better chance of the first two measures though as the third might be rolled into a bigger QE programme (see EuroTower Insights: ECB to Go the Distance Now?, December 5, 2011). As usual, the SMP and the future of the euro will likely feature prominently in the Q and A.  But ahead of the EU Summit on December 8 and 9, we would not expect any major shift in the ECB’s stance on the SMP. Nor would we expect the announcement of outright QE at this stage.
On a related note, the Italian 2 year yield is up slightly to 5.6%, and the 10 year yieldis up to 6.02%. These of course, are lower than the highs they made above 7% in the past few weeks.The Spanish 2 year yield is up to 4.4%, and the 10 year yield is up to 5.44%. The ten year was as high as 6.7% in recent weeks.