By Johanna Treeck
FRANKFURT (MNI) – The European Central Bank is likely to keep a
steady hand on interest rates Thursday but signal a hike for July that
will take the official refi rate to 1.5%.
The ECB may, however, be more cautious about exiting from its
non-standard measures, maintaining the fixed-rate, full-allotment terms
on all of its refinancing operations for another quarter.
The impending second bail-out for Greece will likely be a key topic
during the question and answer session, but hopes of any new insights
are likely to be unrequited.
On the monetary policy front, recent economic data and public
rhetoric from Governing Council members suggest that the central bank
will continue its tightening course in July.
ECB staff forecast for 2011 GDP, due to be released Thursday, are
likely to be revised upwards from the current midpoint of 1.7% after the
Eurozone’s stronger-than-expected first quarter. It’s true that a
slowdown in the recovery has since begun to materialize, but it did not
come as a surprise and should have been incorporated already in the
previous set of projections.
Council member Nout Wellink suggested that signs of economic
weakening will not play a key role in the central bank’s rate setting
considerations. It is “much too early to draw conclusions” relevant to
ECB policy from the apparent slowdown, Wellink told MNI.
More importantly, inflation forecasts for 2011 are likely to be
hiked yet again from the current 2.3%. While most of the upward pressure
continues to stem from commodity prices, core inflation has also begun
to rise and in any event some Council members have cautioned against
attaching too much importance to benign core inflation.
Comments since the mid-month meeting have remained on the hawkish
side. Mario Draghi warned that “the risk of inflation is rising” and
that “there is now a greater need to proceed with monetary policy
normalization so as to prevent expectations of higher inflation from
becoming entrenched.”
Jens Weidmann and Lorenzo Bini Smaghi also pointed to unnerving
signals from the latest Survey of Professional Forecasters, which showed
that the ECB’s hard-earned credibility may be taking a hit, as 50% of
participants expect inflation to run ahead of the bank’s price stability
goal — close to but below 2% — in the medium term.
To ensure that expectations do not become unanchored and that price
stability is ensured, the Council is likely to telegraph a July rate
hike by including the term “strong vigilance” in Trichet’s introductory
statement.
Credibility appears all the more important at the current juncture,
since “voluntary” private sector participation in a second bailout for
Greece may require a credible hard-line from the central bank. Keeping
rates down to accomodate tensions in the periphery could send the wrong
signal and weaken the ECB’s position in ongoing negotiations.
In those talks the ECB has expressed a new openness to private
sector involvement, so long as it could not legally or technically be
seen as a default. Since any tampering with current outstanding
securities would cause such a credit event, the ECB is pleading for a
voluntary rollover of Greek debt with maturities between 2012 and 2014,
once those holdings expire.
Although the ECB insists that any private sector involvement will
have to be completely voluntary, it is hard to see why private creditors
would agree to take more Greek paper — at below-market yields — in
lieu of cash, without at least some implicit pressure.
A potential threat that comes first to mind is a warning that
non-participation would result in a default by Greece, after which the
central bank would no longer accept Greek debt in its refi operations,
triggering a collapse of the Greek banking system with severe contagion
risks.
Trichet will certainly be quizzed on plans for private sector
involvement in a new Greece bailout, but the ECB president is unlikely
to offer any substantive answers on the subject. Instead, he will
probably limit himself to reiterating the ECB’s objection to any form of
sovereign debt restructuring.
While the ECB must stand firm and pursue a monetary policy aimed at
price stability, regardless of tensions in the debt markets, the
potentially turbulent times ahead could encourage the bank to keep
liquidity flowing. The bank, scheduled to announce its new refi schedule
on Thursday, might well postpone a return to competitive bidding for
another quarter.
True, Council members have warned against keeping liquidity support
in place for too long and some, including Juergen Stark, appear to get
increasingly nervous about the ongoing support. On the other hand, they
have admitted that liquidity policy remains tightly intertwined with the
problem of addicted banks located mainly in Greece, Portugal and
Ireland. “It is a question we ask ourselves in Frankfurt every month and
it is a difficult one,” Bini Smaghi said.
With the added complication of negotiations involving the private
sector in a second bailout for Greece, the bond buying program firmly on
hold and European bank stress tests that could lead to additional
tension in July, the ECB may well opt to keep one support line for the
peripheral countries open.
— Frankfurt bureau: +49 69 720 142; email: jtreeck@marketnews.com —
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