• As expected, the ECB reversed its summer hikes by cutting interest rates by another 0.25 %, bringing the refinancing rate back to 1%. It seems that a 0.5% rate cut was not even discussed. We still expect the ECB to deliver another 0.25% rate cut in January and then keep rates unchanged for a prolonged period.
• At the press conference, Draghi surprised positively by announcing 36-month long term refinancing operations (we expected 24 months), widening eligibility criteria for collateral more than expected and reducing the reserve requirement for banks from 2% to 1% (a move that was generally unforeseen).
• In the Q&A, Draghi then spoiled the positive sentiment by saying that any expectations that the ECB would reward a “fiscal compact” by stepping up the Securities Market Programme based on his speech to Parliament last week had been over interpreted.
• The staff growth projections were lowered notably to 0.3% for 2012 and just 1.0% in 2013. The ECB thus clearly expects a prolonged period of low growth. At the same time it projects inflation at 2.0% next year, which could limit how much further the ECB is willing to lower rates.
• Although the ECB surprised by delivering more than expected on non-standard measures, the overall market implication was negative because there were no signs of softening on the SMP issue. The market implication from this was a risk-off move with drops in European stock indices and in EUR/USD.
ECB cut again
The ECB lowered interest rates 0.25% as expected. Draghi revealed that the discussion on today’s rate decision had been “lively” and contrary to what most analysts had expected, it was not whether or not the ECB should cut 25bp or 50bp, but whether it should cut at all. The decision to cut rates was not unanimous. No clear signal was sent with regard to the likelihood of an additional rate cut at next month’s ECB Governing Council meeting.
We still expect the ECB to deliver another 0.25% interest rate cut and bring the refinancing rate to a record low of 0.75% in January. Thereafter we expect the ECB to keep rates unchanged for a prolonged period.
The move on non-standard measures was substantially stronger than expected, reflecting that the ECB is ready to safeguard the banking sector. Nevertheless, Draghi managed to lower risk sentiment in the market by sending signals that clearly downplay the likelihood of a firm ECB response in the wake of the EU Summit.
ECB steps up help for banks with non-standard measures
The ECB surprised positively in terms of additional help for the banking sector. The softening of the non-standard measures includes increasing the maturity on the LTROs, reducing the reserve ratio and loosening the reserve requirements. In detail:
1) The ECB will conduct two LTROs with a maturity of 36 months. These will include an option of early repayment after one year.
2) The collateral requirement will be loosened by,“(i) reducing the rating threshold for certain asset-backed securities (ABS) and, (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. These two measures will take effect as soon as the relevant legal acts have been published.”
3) The reserve ratio, previously 2%, will be lowered 1%.
Overall, this sends a clear signal that the ECB is aware of the stress in the banking sector.
Draghi is lowering expectations for increased SMP buying
The main issue for sovereign bond markets concerned Draghi’s comments regarding possibly stepping up SMP buying in the wake of the EU Summit. However, in this respect Draghi disappointed. Draghi said that his speech to Parliament last week (indicating that the ECB could respond positively to an agreement on a fiscal compact) was over interpreted. Apparently it was not a hint that the ECB would reward an agreement this weekend. Draghi said that:
1) The ECB will not violate article 123, which says that monetarisation of public debt is not allowed.
2) More substantial bond purchases would be against the “spirit” of the Treaty.
3) Ultimately, the decision to move forward in order to restore credibility in the EMU is up to political leaders.
This lowers the likelihood of the ECB opening up the door for a step-up in SMP buying or a more explicit commitment to support the sovereign bond markets. Hence, the euro area still lacks a ‘last resort’ lender. Furthermore, he did not respond constructively to a question on whether or not the ECB could lend to governments via the IMF.
Lowering growth and inflation expectations
The ECB quarterly staff growth projections were revised significantly down for 2012 reflecting the continued deterioration in the economic outlook since its September projections. It forecasts average GDP growth of 0.3% in 2012 (down from 1.3%) and growth of 1.0% in 2013.
ECB inflation projections were revised slightly upwards, which primarily reflects that current inflation remains surprisingly sticky at 3%. For 2011 it was revised up by 0.1 percentage points and for 2012 it was revised up to 2.0% from 1.7%. The staff expects inflation to drop further to 1.5% in 2013.
Market reaction
Although the ECB surprised by delivering more than expected on non-standard measures, the overall market implication was negative, because there were no signs of budging on the SMP issue. The market implication from this was a risk-off move with drops in European stock indices and in EUR/USD.
Market relief on the back of the EU summit was expected due to stronger action by the ECB in the peripheral government bond markets. The likelihood of this has now been reduced considerably; the risk of a renewed negative market spiral has increased substantially in the near term. Of course, there is still an opportunity that the EU Summit will deliver a positive surprise, but if it is not backed by the ECB stepping up the SMP the likelihood of a sustained positive market reaction will be much smaller. If the EU summit does not surprise positively (IMF involvement or bigger EFSF/ESM) it will be negative for the markets next week.
• At the press conference, Draghi surprised positively by announcing 36-month long term refinancing operations (we expected 24 months), widening eligibility criteria for collateral more than expected and reducing the reserve requirement for banks from 2% to 1% (a move that was generally unforeseen).
• In the Q&A, Draghi then spoiled the positive sentiment by saying that any expectations that the ECB would reward a “fiscal compact” by stepping up the Securities Market Programme based on his speech to Parliament last week had been over interpreted.
• The staff growth projections were lowered notably to 0.3% for 2012 and just 1.0% in 2013. The ECB thus clearly expects a prolonged period of low growth. At the same time it projects inflation at 2.0% next year, which could limit how much further the ECB is willing to lower rates.
• Although the ECB surprised by delivering more than expected on non-standard measures, the overall market implication was negative because there were no signs of softening on the SMP issue. The market implication from this was a risk-off move with drops in European stock indices and in EUR/USD.
ECB cut again
The ECB lowered interest rates 0.25% as expected. Draghi revealed that the discussion on today’s rate decision had been “lively” and contrary to what most analysts had expected, it was not whether or not the ECB should cut 25bp or 50bp, but whether it should cut at all. The decision to cut rates was not unanimous. No clear signal was sent with regard to the likelihood of an additional rate cut at next month’s ECB Governing Council meeting.
We still expect the ECB to deliver another 0.25% interest rate cut and bring the refinancing rate to a record low of 0.75% in January. Thereafter we expect the ECB to keep rates unchanged for a prolonged period.
The move on non-standard measures was substantially stronger than expected, reflecting that the ECB is ready to safeguard the banking sector. Nevertheless, Draghi managed to lower risk sentiment in the market by sending signals that clearly downplay the likelihood of a firm ECB response in the wake of the EU Summit.
ECB steps up help for banks with non-standard measures
The ECB surprised positively in terms of additional help for the banking sector. The softening of the non-standard measures includes increasing the maturity on the LTROs, reducing the reserve ratio and loosening the reserve requirements. In detail:
1) The ECB will conduct two LTROs with a maturity of 36 months. These will include an option of early repayment after one year.
2) The collateral requirement will be loosened by,“(i) reducing the rating threshold for certain asset-backed securities (ABS) and, (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. These two measures will take effect as soon as the relevant legal acts have been published.”
3) The reserve ratio, previously 2%, will be lowered 1%.
Overall, this sends a clear signal that the ECB is aware of the stress in the banking sector.
Draghi is lowering expectations for increased SMP buying
The main issue for sovereign bond markets concerned Draghi’s comments regarding possibly stepping up SMP buying in the wake of the EU Summit. However, in this respect Draghi disappointed. Draghi said that his speech to Parliament last week (indicating that the ECB could respond positively to an agreement on a fiscal compact) was over interpreted. Apparently it was not a hint that the ECB would reward an agreement this weekend. Draghi said that:
1) The ECB will not violate article 123, which says that monetarisation of public debt is not allowed.
2) More substantial bond purchases would be against the “spirit” of the Treaty.
3) Ultimately, the decision to move forward in order to restore credibility in the EMU is up to political leaders.
This lowers the likelihood of the ECB opening up the door for a step-up in SMP buying or a more explicit commitment to support the sovereign bond markets. Hence, the euro area still lacks a ‘last resort’ lender. Furthermore, he did not respond constructively to a question on whether or not the ECB could lend to governments via the IMF.
Lowering growth and inflation expectations
The ECB quarterly staff growth projections were revised significantly down for 2012 reflecting the continued deterioration in the economic outlook since its September projections. It forecasts average GDP growth of 0.3% in 2012 (down from 1.3%) and growth of 1.0% in 2013.
ECB inflation projections were revised slightly upwards, which primarily reflects that current inflation remains surprisingly sticky at 3%. For 2011 it was revised up by 0.1 percentage points and for 2012 it was revised up to 2.0% from 1.7%. The staff expects inflation to drop further to 1.5% in 2013.
Market reaction
Although the ECB surprised by delivering more than expected on non-standard measures, the overall market implication was negative, because there were no signs of budging on the SMP issue. The market implication from this was a risk-off move with drops in European stock indices and in EUR/USD.
Market relief on the back of the EU summit was expected due to stronger action by the ECB in the peripheral government bond markets. The likelihood of this has now been reduced considerably; the risk of a renewed negative market spiral has increased substantially in the near term. Of course, there is still an opportunity that the EU Summit will deliver a positive surprise, but if it is not backed by the ECB stepping up the SMP the likelihood of a sustained positive market reaction will be much smaller. If the EU summit does not surprise positively (IMF involvement or bigger EFSF/ESM) it will be negative for the markets next week.