The January European Central Bank meeting passed off relatively quietly. As expected, key interest rates were left unchanged a decision taken by unanimity. The main message from the regular monthly press conference that followed the ECB's Governing Council meeting is that the ECB now wants to assess the impact of the aggressive actions it announced before Christmas before it is willing to contemplate further policy changes. We concluded after that meeting that "unless there is a dramatic deterioration in economic or financial conditions, another near term rate cut or other radical action seems unlikely”. We didn't see such developments in the interim and thus expect the Central Bank to confirm its current stance at its February meeting.
However, this doesn't mean that this week's press conference will go unnoticed. The ECB through president Draghi is expected to make potentially important comments on changes in the collateral that it will accept in its liquidity operations. There may also be some comments about the fiscal compact. Finally, Mr. Draghi will probably be grilled on the Greek PSI and more specifically on why the ECB refused to accept a haircut on the Greek debt it has on its books. So, Thursday's press conference may not be a completely dull affair.
Green shoots confirmed
We start our preview with a brief description of the economic developments since the previous meeting. Early signs that the EMU economic environment might be stabilizing appear to be confirmed by the latest batch of economic data. Indeed, the timeliest activity indicators, the business sentiment data showed some month on month improvement. The composite PMI index rose to 50.4 in January from 48.3 in December, crossing above the boom/bust threshold of 50. It was also the third consecutive monthly improvement, suggesting that the trend has turned upward once again and keeping open the possibility that a negative economic growth figure for Q1 may be avoided. The German IFO business indicator, bellwether for the Germany economy, made a similar move. While it is still early days, these data suggest that the downside risks on growth have diminished and the recovery expected for mid 2012 may come as soon as spring. Of course, important headwinds like the fiscal tightening or a renewed worsening of the debt crisis could still affect the economic outlook negatively. At the January meeting, the ECB still saw "substantial downside risks to the economic outlook”. Since their financial tensions have eased and the US recovery showed signs of acceleration. We don't expect the ECB to upgrade its balance of risks assessment, but are nevertheless looking whether the word substantial could be "omitted”.
If activity indicators were encouraging, there was little news on inflation. According to the flash estimate, inflation stabilized at 2.7% Y/Y in January, in line with expectations. We don't expect the ECB to change its views on inflation that is expected to stay above 2% for several months before declining to below 2%. As a consequence the ECB will asses the risks to the medium term outlook for inflation as broadly balanced, unchanged from their January assessment.
What about credit crunch and LTRO?
Probably the most significant recent release was the ECB bank lending survey. This confirmed our fears that the threat of a credit crunch must be taken seriously. Indeed, December M3 money supply and lending data clearly point towards such a possibility. The net tightening of credit standards surged in Q4 for credit standards to non-financial corporations, were up substantially for loans to households for house purchase and to lesser extent for other consumer credit. Banks also expect a further net tightening in credit standards in Q1 of 2012, albeit more modest than seen in Q4 of 2011. The lending survey also pointed to a weakening economic outlook and the sovereign debt crisis resulting in funding difficulties.
The ECB remarked that the prevalence of tightening appeared to be widespread across larger euro zone countries with the notable exception of Germany. On Monday of last week, there was also a remarkable contrast in unemployment/employment between Germany and most other EMU countries. Now, the divergence between Germany and the rest of the euro area is visible in bank lending too. Germany may benefit from the current debt crisis in some respects and at very least is in entirely different growth circumstances than most other EMU countries – a development that causes significant problems for the ECB in arriving at the correct Euro wide policy setting and, at a far more fundamental level causes major differences in how different countries see the current crisis and its resolution.
Returning to the details of the lending survey, regarding credit demand, banks reported a net decline in the demand for loans to firms, especially for fixed investment, but at a slower pace than in Q3. Also the demand for loans to households declined further, but at a moderate pace. We think that the bank lending survey will raise the alertness of the ECB. Governors will probably feel that their far-reaching liquidity and collateral measures taken in December were timely. Whether the survey will convince them to do more to help the banking sector thereby avoid a credit crunch is more difficult to answer. They may hope that the two 3 year LTRO operations in December and February will prove sufficient to stabilise the sector and the economy and thus wait for more evidence before deciding what to do next. On 29 February the second 3-year LTRO will take place. At the January meeting, president Draghi showed satisfaction with the huge take-up of liquidity at the December three year LTRO and we felt he was encouraging banks to feel no restraints to bid for more funding, implying another substantial addition to liquidity at the end February 3-year LTRO. Recently though, the CEO of Deutsche Bank said he sees a stigma attached to the long-term help offered to banks to help ease a funding crisis. So, we expect the press to dig deeper into the issue by posing Mr. Draghi some questions on the issue, particularly as Bundesbank President Jens Weidmann was recently reported as saying that while the ECB must make sure Banks have access to liquidity, excessive liquidity poses financial stability risks.
We have some reservations about the ECB liquidity policy. It might avert a short term funding crisis, which everybody should applaud, but it raises longer-term risks. Indeed, it might keep banks addicted to ECB liquidity and may delay the re-start of the interbank money market, a vital market for the well functioning of the banking system and the economy. Together with the acceptance of mortgage and SME loans and of certain other credit claims, it seems that the ECB is funding ever more bank assets. Can this be a sustainable business model?
News on collateral?
At the December meeting, the ECB not only introduced the 3-year LTRO, but enlarged the scope of the eligible collateral allowed in the ECB liquidity tenders. That was important as a number of banks in some countries were running out of eligible collateral and thus wouldn't be able to fund them at the ECB.
In the December ECB statement the following was written..." to increase collateral availability.....the underlying assets of which comprise residential mortgages and loans to small and medium-sized enterprises, will be eligible for use as collateral in Eurosystem credit operations. Moreover, national central banks will be allowed, as a temporary solution, to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the national central bank authorising their use. These measures will take effect as soon as the relevant legal acts have been published.”
It seems now that Germany wants the ECB to be more restrictive in the acceptance of collateral, as of course, the government fears that it will carry besides its explicit liabilities in the rescue packages, ever more hidden liabilities. There is also a lot ado about the additional collateral that would accepted by national central banks, which in effect might lead to unequal treatment of banks regarding central bank funding inside the euro area. At the January meeting, Mr. Draghi promised that the collateral changes would be put in place ahead of the February 29 3-years LTRO. So, we expect some kind of communication on the subject.
ECB and haircuts
The negotiations on a Greek second rescue package are still ongoing and at the time of writing there has been no agreement signed on the PSI (Private Sector Involvement) either. So, to make up for the shortfall in Greek funding, from an IMF-calculated a 120% debtto- GDP ratio in 2020, more money is needed. Besides the possibilities of more Greek budgetary savings, a bigger haircut for the private investors or more official loans, pressure is growing for an OSI (haircuts for official creditors, including the ECB). The ECB has always refused to envisage haircuts on their Greek bond portfolio. There are however softer solutions possible, in which eg de ECB would not be paid par for the bonds it bought with a discount, but only receive back the price it had paid for the bonds. Such a scheme might run via the sale to the EFSF. As the Greek issue should very soon be solved, we will be listening eagerly to Mr. Draghi for any hint of a softening of the ECB stance.
In conclusion, while the ECB will keep its monetary policy stance unchanged, the press conference may shed important light on a number of very interesting topics.
0 comments:
Post a Comment