ECB to hold rates
News Article Date: Monday 03rd of August 2009
The European Central Bank appears certain to keep its key interest rate at a record-low 1 percent at its policy meeting this Thursday, but it may sound more optimistic about an economic recovery.
Yahoo! BuzzThe ECB remains very unlikely to follow other central banks, such as the Bank of Israel and possibly the Bank of England, in ending some of the radical monetary easing steps which it introduced to fight the financial crisis.
But comments by ECB President Jean-Claude Trichet may suggest the ECB is starting to think more seriously about how eventually to unwind those steps, given improving economic data in the last several weeks.
The ECB's interest rate decision will be announced at 1145 GMT on Thursday, and Trichet will hold a news conference at 1230 GMT. Following are possible scenarios for the ECB's statements, followed by probable market reactions:
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Comment On This StoryKEEPS RATES ON HOLD
The ECB keeps its main refinancing rate at 1 percent and the deposit rate, which acts as a floor for the money markets, at 0.25 percent.
PROBABILITY: Very high. The latest Reuters poll of analysts showed all 75 economists expected the ECB to keep rates on hold.
MARKET IMPACT: Expectations are so overwhelmingly for steady rates that this outcome would have almost no impact on markets.
A few investors are looking for a further rate cut around this autumn; any decision to cut as soon as this week would not only undermine the euro but also hurt stocks and prompt a flight into government bonds by suggesting the ECB felt economic conditions were worse than the market had thought.
Trichet repeats that interest rates are at an 'appropriate' level. This would reinforce the consensus that any further rate cut remains unlikely; there is still no serious speculation about any rate hike this year.
PROBABILITY: Very high.
MARKET IMPACT: Dropping this phrase would increase speculation about a rate cut in the next couple of months, putting downward pressure on the euro.
SIGNALS RATES COULD STAY FLAT FOR LENGTHY PERIOD
Trichet could take the unprecedented step of saying the ECB was ready to keep rates on hold for an extended period, to reassure the markets of policy continuity and increase banks' willingness to lend.
PROBABILITY: Low. Analysts believe the ECB feels the economic outlook is too uncertain; making such a pledge would also contradict the ECB's longstanding insistence that it never pre-commits on policy.
MARKET IMPACT: The euro could weaken and bond prices and stocks rise as the market interpreted the statement as a pledge not to conduct any early tightening. But the impact would probably be minor.
Markets are already pricing in rates staying on hold well into next year; in the latest Reuters poll, just seven of 73 economists said rates would be above their current level at the end of the second quarter of 2010.
BRINGS FORWARD TIMEFRAME FOR RECOVERY
Trichet brings forward the ECB's public timeframe for economic recovery. Previously, he has forecast positive quarterly Gross Domestic Product growth by mid-2010; he might now talk of a sustained recovery beginning sooner.
PROBABILITY: Unlikely. Analysts think the ECB will wait for more countries to report second-quarter GDP figures, and for the next set of ECB staff projections to be released in September, before changing its formal outlook. By playing it safe in this way, the ECB can preserve maximum policy flexibility.
However, Trichet may change his rhetoric mildly and sound slightly more optimistic. At the last ECB meeting a month ago, he said: 'Recent data releases and survey information provide further indications that economic activity over the remainder of this year is likely to remain weak.' The rest of the year may no longer be characterised in this way.
Trichet is also likely to try to reassure the markets that falling consumer prices in the euro zone will prove temporary and are due to the base effects of commodity price fluctuations.
MARKET IMPACT: Explictly bringing forward the timeframe for economic recovery would likely lift the euro as well as stocks. Bonds would suffer, though perhaps only slightly because inflationary pressure remains so weak; the 10-year Bund yield has been negatively correlated with the FTSEurofirst 300 stock index over the past week.
ANNOUNCES NEW UNCONVENTIONAL MEASURES
The ECB could conceivably surprise markets and announce plans to buy up other types of assets to ease policy.
PROBABILITY: Very low. Money markets are still digesting the record injection of 442 billion euros in one-year funds in late June, and the ECB's covered bond purchase programme has just started. Several ECB policymakers have said the central bank needs time for its previous actions to take effect.
MARKET IMPACT: Large. The market does not expect any further radical action from the ECB unless the economy turns clearly worse and bank lending deteriorates further. Bond prices would rise strongly, while the euro would fall; stocks would probably drop, although bank shares could benefit if the ECB took fresh steps to improve banks' balance sheets.
ADDS A SPREAD TO SEPTEMBER 12-MONTH TENDER
Trichet could comment on the next 12-month liquidity operation and say whether the ECB planned to add a spread to fix the interest rate above the central bank's main policy rate.
The first-ever 12-month operation, conducted without a spread at 1.0 percent in June, attracted heavy demand. But banks have continued to deposit much of the money back at the ECB on an overnight basis, so the ECB could add a spread on the grounds that banks have borrowed more ultra-cheap money than they need.
PROBABILITY: The ECB is unlikely to give details of the next 12-month tender; the tender will be held in late September, and the central bank will probably keep its options open until closer to the date.
Dissatisfied with sluggish commercial bank lending, however, Trichet could reiterate that banks have a responsibility to lend out funds obtained in 12-month tenders to firms and consumers.
MARKET IMPACT: Attaching a spread to the September tender would be seen as a preliminary step towards monetary tightening; it would likely increase money-market interest rates and hurt bond prices.
GIVES SPECIFICS OF EXIT STRATEGY
Trichet could reveal specific details of an 'exit strategy': plans to wind up radical monetary easing steps. For example, he might discuss an early end, or a scaling back, of the ECB's covered bond purchase scheme.
The scheme, which began in July, aims to buy 60 billion euros of bonds over 12 months and has so far bought slightly more than 4 billion euros.
PROBABILITY: Very low. Some ECB policymakers, including Juergen Stark and Axel Weber, have called for the central bank to withdraw policy support quickly when signs of economic recovery and inflation pressures emerge. But others, such as Guy Quaden and John Hurley, sound much more cautious.
Trichet has said it is reasonable to think about exit strategies and that the ECB's non-conventional measures could be unwound rapidly once the economic environment improved.
PROBABILITY: Very low; the ECB does not appear close to the degree of consensus needed to scale back policy support.
However, to reassure the markets on the issue of inflation, Trichet is likely to stress the ECB is committed to unwinding emergency measures when warranted.
MARKET IMPACT: Large. Any sign that inflation hawks were gaining the upper hand in the ECB would hurt bond prices. The effect on the euro and stock prices would be more unpredictable; they could rise if the ECB's new stance was seen as a vote of confidence in the economy.
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