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From Accountingnet.ie Recession
While today’s announcements are important, they contained no major surprises. The ECB appreciates the importance of avoiding any words or actions that might create instability in still nervous and fragile markets. The clear message was one that the ECB will continue to wind down its exceptional support to the financial system but we remain a substantial distance from any prospect of a change in the ECB’s monetary policy stance. The ECB has consistently emphasised the distinction between its liquidity actions and its broader policy measures. Although the lines between the two can become blurred from time to time, markets are satisfied - at least for now, that the ECB can continue to reduce its liquidity support through the next six to nine months without any consequences for monetary policy or, indeed, much problem for markets. Eurozone Recovery Continuing But Not Threatening The economic picture Mr. Trichet painted today was one which would justify continuing to unwind liquidity measures today while deferring monetary policy changes until a still fairly distant tomorrow. Although Mr. Trichet acknowledged that the upturn is likely to remain uneven, he also indicated that the latest information confirmed ‘the economic recovery in the Euro area is on track’. Significantly, the ECB has revised it’s growth and inflation forecasts for 2011 marginally upwards. At a rate of 1.5%, Eurozone growth next year is still relatively modest particularly in the light of the weakness of the past couple of years. This also means that inflation at 1.2% in 2010 and 1.6% next year is likely to ‘remain subdued over the policy relevant horizon’. So, growth and inflation are both expected to remain on trajectories that are neither too strong or too weak for comfort. As a result, the ECB takes the view and markets agree that it has scope to focus on unwinding the vast bulk of its liquidity support through the remainder of this year before turning its attention to broader policy requirements in 2011. The uneven nature of the economic recovery prompted the ECB to suggest today that ‘it is more appropriate to look through the quarterly volatility and to compare growth developments on a half year basis’. A logical extension of this approach would be that the ECB would be relatively slow to make judgements as to when circumstances might suggest a need to begin raising official interest rates. It will take some time, possibly until September to know whether widespread weakness in activity around the turn of the year was unduly influenced by severe weather. With substantial budgetary cutbacks and adjustments to private sector balance sheets likely to restrain domestic demand through the remainder of 2010 and well beyond, it would seem ambitious for the ECB to tighten policy before the end of this year, particularly as today’s liquidity decisions imply a sharp unwinding of term liquidity support in the final months of 2010. For these reasons, it seems more likely that official rates will not rise before early 2011. Liquidity Wind-Down To Continue At A Steady Pace The specific announcements on liquidity made today by the ECB were along expected lines. The final 6 month liquidity operation scheduled for the end of this month will be at a fixed rate which will be based on the prevailing ECB policy rate through the period and the ECB will also allocate all funds requested by commercial banks. This is identical to the approach used for the final 12 month tranche of funding back in December and, as such, is precisely as the market expected. Reflecting a clear desire to progress the winding down of emergency support facilities, the ECB also announced today that from the end of April, its 3 month refinancing operations would revert to their pre-crisis structure of variable interest rates and no guarantee that all demands for funds would be met. However, any risk of near term disruption from this switch was all but removed by a promise to allocate sufficient funds ‘with the aim of ensuring smooth conditions in money markets and avoiding any significant spreads’ between the rates bid by banks and the prevailing ECB policy rate. In addition, the ECB announced that one month refinancing would be available at fixed rates and full allocation ‘for as long as necessary – and at least until … 12 October 2010’. So, today’s announcements commit the ECB to providing as much liquidity as is warranted for the next six months but also significantly shorten the maturity profile of this liquidity. Quite A Long Way Will Be Travelled By End 2010 It would be entirely inaccurate to suggest the ECB is anywhere close to returning to the sort of liquidity support that prevailed before the crisis, but it has now set out a time-path whereby commercial banks will have to return to a reliance on markets for anything other than short term funding before the end of this year. By keeping markets relaxed about both the amount and the pricing of the shorter dated liquidity that it will provide in coming months, the ECB has ensured that the adjustment is a relatively smooth process – at least for the moment. These relaxed conditions could change towards the end of the year when the final longer term refinancing operations mature and questions arise about liquidity support and ECB policy rates in 2011. For now, markets remain relaxed. Indeed, they were further comforted by Mr. Trichet’s response to a question today when he indicated that overnight (EONIA) rates ‘would not rise in the short term’. So, for the next couple of months at least, shorter dated market rates may continue to lie below the ECB’s main policy rate. Will Markets Remain As Calm? By the end of this year the ECB will have unwound all its 12 and 6 month liquidity support to the banking system and made 3 month support less freely available. By laying out a clear time path for this adjustment and reassuring traders that ample shorter dated support will be provided in its place for the transition, the ECB’s exit strategy has caused few concerns for financial markets. An additional and important source of comfort has been the emerging view that the normalisation of liquidity would not be accompanied by a formal tightening of policy. In the near term, little is likely to disturb this calm. However, the final months of 2010 may provide a sterner test of the ECB’s credibility as traders begin to focus on the prospect of less favourable liquidity conditions and the beginning of the road towards higher policy rates in early 2011. KBC Bank Ireland plc
A member of KBC Group NV Registered in the
The above information is believed to be reliable, but is subject to change without prior notice. © Copyright 2005 by Accountingnet.ie |
