Thursday, December 8, 2011

ECB meeting - Lender of last resort, but not for governments

The ECB cut interest rates by 25bp, lowering the refi rate to 1.0%. Within a month time, the new ECB president Mario Draghi has eradicated the hotly contested rate hikes of his predecessor. Ironic enough, the rate reversal was not the most sensational decision of today’s ECB meeting. With additional non-standard measures, the ECB took another unprecedented strike to tackle tensions in the money market.

The rate cut was motivated by a further worsening the economic outlook. As a tribute to the latest slowdown of confidence indicators and economic activity, the ECB considers risks to the economic outlook to be substantially to the downside. This downside risk is reflected in a significant downward revision of the ECB staff projections for GDP growth. For 2012, GDP growth is expected to come in at 0.3%, from 1.3% in September. For 2013, GDP growth is expected to pick up again to 1.3%.

On inflation, the ECB today sent a somewhat confusing message. As in November, the ECB still expects headline inflation to drop below 2% in the course of next year. However, the ECB staff projections were revised upwards to 2.0% for 2012, from 1.7% in September, and 1.5% in 2013. According to the ECB risks to price stability balanced. This was also reflected in Draghi’s comment that there was currently no risk of deflation.

The rate cut was one thing, liquidity measures were another thing. The ECB took another unprecedented attempt to tackle money market tensions. In more detail, the ECB presented five more measures: i) two 36-months LTROs at full allotment, with the first operation being allotted on 21 December 2011; ii) a reduction of the rating threshold for certain asset-backed securities (ABS) from AAA to A for ABS comprising residential mortgages and loans to SMEs; iii) national central banks will be allowed to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria; iv) reduction of the reserve ratio from 2% to 1%; and v) a temporary discontinuation of fine-tuning operations carried out on the last day of each maintenance period. Overall, the ECB tries almost everything it can to prevent a credit crunch in the Eurozone.

Prior to today’s ECB meeting, the optimal sequencing of the Eurozone’s final Grand Bargain was a rate cut and more liquidity measures from the ECB today, a ‘fiscal compact’ from political leaders with a clear roadmap towards more political integration and a fiscal union tomorrow and a clear signal from the ECB to do more after the EU summit. At today’s meeting, ECB president Draghi put a stick into the spokes of the Grand Bargain’s wheel. While Draghi had opened the door for more ECB support last week, he closed it again today. According to Draghi, it was up to politicians to solve the debt crisis. The ECB would not respond to a fiscal compact and would not increase its bond purchasing programme. Whether this clear-cut statement was for real and only part of the ECB’s poker game, only the coming days can tell.

All in all, the ECB delivered all it could without crossing the line of Germanic rules of central banking. The last trump card remains up the ECB’s sleeve. For the time being, the ECB does everything to be the lender of last resort for the economy and the financial sector but not for governments.

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