ECB Preview - Draghi Likely To Stick To Verbal Intervention

We expect the ECB to keep rates on hold and abstain from introducing new measures. The main reason is that we see more and more signs that the economy is about to recover and that perceived tail risks have been significantly reduced.

ECB president, Mario Draghi, is likely to argue that the early prepayment of 3Y LTROs and the resulting rise in interest rates is a healthy sign of normalisation rather than premature de facto monetary policy tightening.

We think that currency appreciation may trigger a refi rate cut only if EUR/USD moves substantially higher (e.g. above 1.40) and the ECB sees signs that the recovery is losing momentum. Draghi will probably start out with verbal intervention. His success with the OMT should be highly motivating in that regard.

Rate cuts seem very unlikely
A Reuters poll showed that analysts on average see a 12% chance of a rate cut this month. We put it at about 2%. At the press conference after the last ECB Governing Council meeting, Mario Draghi pretty much took rate cuts off the table. Since then, market sentiment has improved further and we have seen more signs that the economic recovery is gaining momentum both globally and in the euro area – although it is a slow process. A rate cut on Thursday would thus be very surprising to us.

The reduction in excess liquidity as a result of banks’ voluntarily early repayments of three-year LTRO loans has caused interest rates to increase and helped EUR/USD to strengthen. We agree that this is a cause for concern, but that it isn’t enough to trigger a ECB rate cut as long as the economic situation is improving.

LTRO repayment and rising interest rates
At the press conference, Mario Draghi is likely to argue that the early prepayment of 3Y LTROs and the resulting rise in interest rates is a healthy sign of normalisation rather than a premature de facto monetary policy tightening. We think that there is some truth to both stories. Banks returned EUR137bn in the first week and only EUR3.5bn in the second, bringing excess liquidity down around EUR450bn. We expect to see very low weekly prepayments, so even if EUR150bn is returned on 27 February when banks get the first opportunity to prepay LTRO II, excess liquidity should still be plentiful (around EUR300bn). The normalisation of excess liquidity and thus the return of EONIA overnight to levels around the refi rate is unlikely to happen any time soon. In fact, if excess liquidity remains well above EUR200bn during 2013, then EONIA fixing is not likely to increase much this year. Thus, the impact of a refi rate cut will remain rather limited and as we have argued before, a deposit rate cut seems unlikely.

In addition, Draghi is also likely to emphasise that the ECB will ensure that the liquidity situation remains consistent with the accommodative monetary policy – in line with what ECB Executive Board member Peter Praet said on 29 January at the Annual Danish Top Executive Summit 2013 in Copenhagen: “We will exert vigilance to ensure that – notwithstanding the legitimate decisions of individual banks to reduce their liabilities to the central bank – the overall liquidity conditions prevailing in the money market will remain consistent with the degree of accommodation that the current outlook for prices and real activity warrant”. This should be interpreted as a fairly dovish signal from the ECB.

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