ECB postpone exit once again

Despite upward revisions to the growth forecasts, ECB president Trichet tried to strike a cautious note in today’s meeting. As expected, rates remained on hold. As also expected, with thanks to Bundesbank president Weber, the ECB today announced an extension of its liquidity measures with full allotment until early next year. As a consequence, liquidity provision will remain ample, a next exit attempt will at the earliest only start in the first quarter of next year and rate hikes are still a distant future.

As regards the ECB’s assessment of the economy, ECB president Trichet tried to send a two-sided message. On the one side, the ECB sees a “positive underlying momentum” in the Eurozone economy since the recovery started and the ECB’s staff projections were significantly revised upwards. For 2010, the ECB now expects GDP growth of 1.6%, from 1.0% in June. For 2011, GDP growth is now expected at 1.4%, from 1.2%. On the other side, Trichet stressed prevailing uncertainty and even cautioned against too much optimism. In the Governing Council’s view, risks to the latest staff projections were slightly tilted to the downside.

As regards inflation, Trichet reiterated the almost traditional distinction between headline inflation and domestic price pressures. While strong global growth and energy prices could still lead to higher headline inflation, the ECB expects domestic price pressure to remain low. In the latest ECB staff projections, headline inflation is expected to come in at 1.6% in 2010, from 1.5% in June, and at 1.7% in 2011, from 1.6%.

While the ECB’s macro assessment did not bring any surprises and can be summarised as “a gradual sub-potential recovery without risks to price stability”, the ECB presented the official postponement of its liquidity exit. As expected, the ECB will provide unlimited liquidity until the first quarter of 2011. One-week and one-month refinancing operations will be offered at full allotment at least until 18 January 2011. Full allotment will also be applied to the monthly 3-month LTROs until the end of the year. Last but not least, the ECB will also carry out three fine-tuning operations on 30 September, 11 November and 23 December to smoothen out the expiring 6-month and 12-month refinancing operations. These measures are too big to only tackle the end-of-the-year problem for banks. They show that, despite the positive stress tests in July, the ECB is still concerned about the health of the financial system.

All in all, after Axel Weber’s comments almost two weeks ago, today’s meeting was almost predetermined to become a damp squib. Even the extension of the liquidity measures did not come as a surprise anymore. Today’s meeting and particularly the decision on the liquidity programme shows that the ECB still does not trust the recovery and the health of the financial system. The attempt to enter the exit lane has once again been postponed.