Viewpoint: Rien ne vas plus, at least for some time to come!

ECB: Rien ne vas plus, at least for some time to come! The April ECB meeting left rates unchanged, with no news on the unconventional measures, and a broadly unchanged rhetoric.,….

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Draghi confirmed that it is still premature to start a debate on an exit strategy, as the ECB is still assessing the effects of the 36-month LOTRs, and both inflation expectations and the slack in the economy are stable.

We continue to believe the ECB will not announce further 36-month LTROs, but full-allotment will be maintained at least until the beginning of 2013. The overall picture remains fragile, and it is premature to talk about any exit strategy. Draghi reasserted that the LTROs were designed to give euro area banks the time to recapitalise in an orderly manner, and governments the possibility of taking advantage of a relatively quiet phase on the financial markets to advance the fiscal consolidation process.

The LTROs have generated a “timed increase in money base”, aimed at guaranteeing unlimited liquidity to the system, although Draghi noted that the operations do not, and cannot, replace the process of recapitalising the balance sheets of banks, and even less so of governments. Draghi indicated that it is not possible to set an exact date to draw conclusions on the effects of the LTROs. In order to verify the effects of the LRTOs on the system, the ECB looks at national consolidated balances sheets every day, to verify to what extent the rise in liquidity translates into an increase in deposits, loans and/or reserves with the ECB. Draghi stressed that it is still too early to assess the impact of the operations on the credit trend.

Constraints on the supply of credit, and on fund flows on the interbank market are due to 1) lack of funding sources at acceptable costs (the ECB has managed this issue); 2) lack of capital (a problem the ECB cannot resolve); 3) the perception of risk tied to concerns that counterparties are not sufficiently liquid (a risk factor to which the ECB has indirectly contributed) and/or solvent, due to lack of capital, an issue to solve which the ECB is almost powerless; 4) lack of demand, which the ECB can support, as it is doing, with exceptionally low rates. As regards concerns tied to collateral, the ECB is comfortable with the new rules, and this indicates that there is no rush to return to an ordinary regime.

Draghi reasserted that already in March the risks tied to new loans were mitigated by the hefty haircut applied (53% on average, but as large as 75% in some cases). As regards the ECB’s decision of 21/3/2012, based on which national central banks are not obliged to accept as collateral bank bonds guaranteed by sovereign states that have applied for financial assistance from the IMF and the EU Commission, this simply indicates that the risk tied to this type of asset should not necessarily be extended to other countries. However, Draghi clarified that the decision will have limited effects in practical terms. As regards Greek banks, Draghi said that the EUR 25Bn in funds issued as part of the second bailout package should guarantee access for institutions to OMOs in the short term, and banks will also be able to continue to refinance themselves through the ELA. We stick with our view that interest rates will stay put for an extended period of time. The ECB has confirmed the signs of a stabilisation of activity on modest levels, and downside risks to the growth scenario  in line with the assessment made a month ago. Risks to the inflation trend are skewed to the upside in the short term, in light of persistently strong pressures from the energy component; however, in the medium term the ECB expects the inflation trend to stay in line with the price stability target. The ECB is checking the pass-through of energy prices to the distribution chain, and in particular to the prices of domestic goods, but this does not mean that the ECB has not adopted sterner tones on risks to the inflation trend. Also, the ECB reasserted that the price stability target must be pursued for the euro area as a whole, and that individual countries are responsible for guaranteeing the competitiveness of domestic economies by adopting an appropriate mix of policies.

While divergences are physiological, Draghi specified that a targeted inflation rate of close to, but below, 2%, should be reached not through an increase in inflation in virtuous countries, as opposed to deflation in less virtuous countries, but gradual convergence towards an inflation rate of close to 2% in all countries.


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