Viewpoint: The ECB left interest rates unchanged

1) The ECB left interest rates unchanged (and did not debate the possibility of a cut, which means that chances of a reduction of the refi rate in the months ahead are slim). The change in collateral eligibility rules appears to be an additional measure…..


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(on top of the substantial ones already put in place) to counter the risk of a credit crunch and ease tensions on the financial markets. Lastly, it is still unclear what role the ECB will play in the deal to be closed on Greece, although the sale of GGBs to the EFSF at purchase price now seems to be a possibility.

2) The Eurogroup has postponed to Wednesday, 15 February, a final decision on the granting of the new bailout package to Greece.

1) As widely expected, the ECB meeting came to a close leaving rates unchanged.

During the press conference, President Draghi added that the option of a cut was not discussed, letting on that chances of a refi rate cut in the months ahead are slim.

MACRO SCENARIO – The assessment of the risks weighing on the macro scenario changed little compared to the January press release, although the tone is slightly less pessimistic. The ECB confirmed the existence of “downside risks” (no longer defined as “substantial”, however) in a still very uncertain context, while also confirming, based on greater evidence than a month ago, the “tentative” signs of a stabilisation in economic activity (albeit at modest levels) yielded both by surveys and real data; these signs were accompanied by easing stress on the financial markets (also thanks to the measures adopted by the ECB itself). In essence, after a “very weak” fourth quarter, the cycle does not seem to have deteriorated further at the beginning of 2012, and the ECB scenario (on which we agree) points to a very gradual recovery in the course of the year. As regards inflation, Draghi confirmed that risks are

balanced and that it will take the CPI several months to drop back in line with the target.


RULES ON COLLATERAL – Mr. Draghi confirmed the approval of new collateral eligibility criteria, announced on occasion of the 8 December meeting, for the seven National Central Banks that presented proposals in this direction (Ireland, Spain, France, Italy, Cyprus, Austria and Portugal), and that will allow the temporary acceptance of “additional credit claims” as collateral in Eurosystem credit operations1. In essence, each of the NCBs involved will present (based on shared guidelines) specific national acceptance criteria for additional credits, that will have to be approved by the ECB’s Governing Council. Detailed information on the specific national criteria are available on the websites of the respective NCBs2. Draghi acknowledged that these changes imply greater risk for the Eurosystemn, but stressed that such risk will be “managed very well”, with “very stringent” conditions, that should reduce the amount of acceptable collateral by almost two-thirds (compared to the nominal value of total credits).

The ECB will review the situation concerning collateral in six months. Draghi added that decision to change rules on collateral was taken to prevent risks on credit, especially in the countries hit hardest by the crisis, and to guarantee that monetary policy slackening transfers entirely to the economic cycle. The ECB President did admit, however, that the discussion on collateral was not unanimous within the Governing Council. The change is an important one: for Italian banks, the Bank of Italy estimates that additional collateral potentially eligible at around EUR 170Bn, or EUR 70Bn after application of risk control measures (at present, collateral offered as guarantee by Italian banks is worth around EUR 290Bn, of which only EUR 42Bn in bank loans).

LTRO – Draghi, in addition to stressing (quite rightly so, in our opinion) the decisive role played by the introduction of the new three-year auctions in easing market tensions, said that the effects of the December auction “are still unfolding”, and may not have been fully reflected, for instance, on the results of the latest BLS (which pointed to a sharp deterioration in credit conditions between the end of 2011 and early 2012). Denying rumours quoted by press agencies (last week’s FT), and in line with our expectations, Draghi said he expected demand for funds at the next three-year LTRO at the end of February to be around the level (and not much higher) of the previous one (EUR 489Bn). On one hand, in fact, reputational risk, given the success of the first auction, seems not to apply, and the change in rules on collateral could push more banks to demand funds, but, on the other hand, we suspect banks’ financing needs may not play a more significant role than they did last December, and the drop in shortterm yields that has already taken place may have cooled the pursuit of carry trades.


THE ROLE OF THE ECB IN THE GREEK DEAL – Draghi, in addition to confirming he had received confirmation from the Greek Prime Minster that an agreement had been reached on the additional austerity measures, and that the “vibrations” were that an agreement on PSI is also very close, avoided commenting on the role the ECB will play in the complex negotiations over Greece, leaving all decisions on the topic to the Eurogroup. Specifically, neither confirmed nor denied rumours seen in the press in recent days (WSJ and Kathimerini) based on which the ECB could take part in the deal by selling its GGB portfolio to the EFSF at purchase price. The difference between the discounted price at which the ECB purchased the bonds and their nominal value is estimated at around EUR 11-12Bn. On this topic, Draghi simply said that talk about the ECB sharing losses is “unfounded”, as this would in effect correspond to the monetary financing of a member state. However, this would not be so, and could therefore be accepted, if rather than share losses the ECB renounced profits, distributing them to member states in proportion to their contribution to ECB capital; the idea of a bond “swap” with the EFSF seems to fall into this latter category of options. Yet, it remains unclear how the EFSF’s participation in a haircut of Greek debt would not violate the statutory prohibition against the monetary financing of member states. Draghi also added that any “legal tricks on Greek bonds” will be avoided. Lastly, Draghi said he considers the new “fiscal compact” as a major event, that should viewed as a first timid step towards a fiscal union, which remains the longterm objective.

In brief: 1) the likeliest scenario now seems to include unchanged rates; 2) the change in collateral eligibility rules appears to be an additional measure (on top of the substantial ones already put in place) to effectively ease tensions on the markets; 3) it is still unclear what role the ECB will play in the deal on Greece, but the sale of GGBs to the EFSF at purchase price now seems to be a possibility.

2) The extraordinary Eurogroup meeting came to an end without a final decision being taken.

The euro area Finance Ministers acknowledged the additional fiscal measures and the moves the Greek government intends to make to obtain granting of the second bailout package from official creditors, but demanded more tangible efforts. In the press conference that followed the meeting, president Juncker stressed that conditions are still not in place for the approval of the bailout package, and therefore in order for the funds to be issued: 1) the Greek parliament must approve (in all likeliness on Sunday) the package agreed with the Troika; 2) additional structural corrections worth EUR 325M must be “rapidly identified”; 3) political party leaders must offer “strong political assurance” guaranteeing implementation of the package, also considering the impending elections. Juncker made it clear that if these conditions are not met, the funds will not be issued. As regards PSI, Juncker said that the agreement is a necessary condition for the approval of the package, and that the Troika is still working on the debt sustainability analysis to assess whether the debt/GDP ratio target of 120% of GDP by 2020 can effectively be reached. Based on the information available, Juncker called a meeting of the Eurogroup work group next Tuesday, and a new extraordinary Eurogroup meeting on Wednesday, 15 February: if the three missing conditions are, the issue of the funds will be approved and the national parliamentary procedures will be arranged.


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