FRANKFURT (MNI) – The European Central Bank appears likely to hold
off on any further winding down of non-standard policy measures until
next year in a move that may suggest the central bank’s policies will be
increasingly geared towards the lagging economies and troubled sovereign
debt of peripheral countries.
The renewed widening of peripheral EMU debt spreads raises the risk
that the ECB may not only delay its exit from non-standard measures but
also from historically low interest rates.
“Most of these discussions about the continuation of the exit I
think will be focused on the first quarter,” Governing Council member
Axel Weber said last week. He specifically ruled out changing the full
allotment policy for October’s 3-month tender.
Council members Athanasios Orphanides and Patrick Honohan had
previously hinted that they preferred a continuation of generous
liquidity provisions, but Weber’s position as the ultra-hawk on the
Governing Council means that his support for continued accommodation
gives a stronger signal of actual upcoming policy decisions.
The Governing Council is due to decide at its next monetary policy
meeting on September 2 how to proceed with liquidity provisions from
October onwards.
Postponing the exit from non-standard measures once again would
appear to contrast with the ECB’s stated desire to reduce liquidity
supply “in tandem” with improving market conditions.
Indeed, money market conditions have improved substantially. Excess
liquidity has fallen to around E100 billion from E350 billion in June.
Demand for ECB financing dropped to E448 billion in July from E496
billion in June, while the transactions volume in the interbank has
recovered significantly.
Contrary to the overall trend, however, demand for ECB liquidity
was still on the rise last month in some peripheral countries, including
Spain, Ireland and Greece. While ECB borrowing from banks in Germany
fell to E115 billion from 225.6 billion, in Greece it rose to E96.2
billion from E93.8 billion, and from around E50 billion at the start of
the year.
There is a convincing argument to be made that removing extra ECB
support to the periphery would bear systemic risks. Extending liquidity
provisions is thus not intended to boost only weaker banks in the
periphery but the system as a whole.
Starving Greek banks of liquidity, thus sparking a credit crunch or
even potential bank failures, could well take the Eurozone’s sovereign
debt crisis to new heights. Fresh fears of counterparty risks might in
turn impair European interbank lending once again.
The recent return of sovereign debt problems has already raised the
risk of fresh interbank market troubles as it is. Ireland’s rising cost
of supporting its banks sent sovereign Irish spreads spiraling again
earlier this month. Despite ECB intervention — bond buys grew to E338
million from E10 million — the rising yields quickly spread to other
peripheral countries. Standard & Poors’ downgrade of Irish sovereign
debt on Tuesday further exacerbated these concerns.
There can thus be no doubt that should the ECB indeed delay further
exit measures until next year, it would be acting in line with it maxim
— not always religiously observed, it must be said — of making policy
for the Eurozone as whole and not for individual member states.
The risk of spillover effects from the weak countries to the rest
of the Eurozone via the debt crisis also applies to the setting of
interest rates amid a two-speed recovery. And latest data suggest that
the ECB will eventually have to grapple with this dilemma.
The August Ifo business climate indicator, published Wednesday,
extended July’s record jump, suggesting the German economy will continue
to post sound growth after its record GDP rise of 2.2% q/q in 2Q. The
six month outlook deteriorated only slightly and remained well above the
historical average. Germany’s recovery appears increasingly broad-based,
suggesting that it may be able to weather an expected decline in exports
relatively well.
There’s less reason for optimism with regard to the outlook for the
peripheral countries. After a much weaker performance in 2Q (Italy
+0.4%, Spain +0.2%, Greece -1.5%), August’s preliminary PMI data suggest
that growth outside of Germany and France will remain sluggish and may
come to a near standstill. Austerity measures are likely to weigh on
domestic demand ahead offering no compensation for potential export
declines.
Nevertheless, thanks to Germany’s stellar recovery, ECB staff
forecast for Eurozone growth, due to be released in September, are
likely to show a fresh upward revision in the 2010 GDP figures.
The question is whether the ECB, when the time comes, will look at
the aggregate EMU growth figures and the signals they might send
regarding the output gap and potential inflationary pressures ahead, or
whether the central bank will instead be held back by fear that rate
hikes could exacerbate the sovereign debt situation.
Deeper or more protracted recessions in peripheral countries as a
result of higher interest rates would impair the ability of governments
to cut deficits and debt levels, adding fuel to default speculation.
Such prospects could clearly justify delaying rate moves in the interest
of the region as whole.
On the other hand, the risk of keeping interest rates too low for
too long — and thus potentially unmooring inflation expectations —
seem higher than the danger of maintaining extra liquidity support for
some months longer.
But ECB policy appears to be increasingly held hostage by the
sovereign debt crisis. In its struggle to keep the Eurozone together,
the ECB might yet keep rates on hold for longer than aggregate data
would justify.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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