European Central Bank Policy Meeting Preview

Thursday 4 July 2013, 12.45 BST: Rate decision

Thursday 4 July 2013, 13:30 BST: Post-meeting press conference with ECB president Mario Draghi

Markets expect the European Central Bank (ECB) to hold its refinance rate at 0.5% and its deposit rate at 0% at its July monetary policy meeting. However, the focus will be on ECB president Mario Draghi’s post-meeting press conference; journalists certainly have plenty of ammunition to hit Draghi with.

At the June press conference Draghi welcomed the tightening in the ECB’s balance sheet, despite the fact that Eurozone inflation is undershooting the ECB’s 2% target, and the Eurozone has been entrenched in recession for the last six quarters. During the press conference, and in subsequent speeches, Draghi has reiterated his view that looser monetary policy and better confidence is expected to support economic growth in the second-half of this year – all signs suggest that he will further reinforce this view on Thursday.

The ECB will take comfort from some of the recent economic data releases. The latest purchasing managers’ surveys, for example, show that a corner has been turned in both the Spanish and Italian manufacturing sectors. Spanish manufacturing finally moved out of contractionary territory, ending a 25-month of below-50 readings, and Italian manufacturers are the most upbeat in almost two years (albeit remaining in contractionary territory). Surprisingly, it was Germany that disappointed, with its manufacturing PMI slipping to 48.6 on weaker Chinese demand.

But the overall Eurozone manufacturing PMI index is still in contraction territory, though it is on a rising trend, and some analysts note that the European recovery is lagging among G10 nations. Other challenges are also evident. Unemployment in the Eurozone inched higher in May to 12.2%, from 12% in April (fortunately, however, it didn’t rise to another record high). And the broader composite PMI has also slipped in June.

While inflation remains below the ECB’s 2% target at 1.6%, it did come in 0.2% higher from May’s figure, and core inflation is stable at 1.2%, underscoring that inflationary pressures remain muted. While this leaves the ECB with room to loosen conventional monetary policy further, the generally encouraging momentum of economic data will be enough for the ECB to justify keeping rates on hold.

We expect Draghi to give a dovish outing at the post-meeting press conference, continuing to drive home the message that ECB policy will remain accommodative and the central bank has the tools to support the Eurozone’s economy.


The stench of crisis is returning in the Eurozone. With the Portuguese government on the brink of collapse, questions hanging over Greece’s next tranche of bailout cash, and continuing concerns about Cyprus, how is the ECB able to intervene in the markets to prevent a full-blown crisis from flaring up?

Portugal: After two high-profile government resignations, the prospect of an election in Portugal is on the cards, and this may threaten Portugal’s bailout deal. Although European Commission president José Manuel Barroso expects a solution in the short term, the market is not so convinced: Portugal’s 10-year government debt yields are once again being bid above 8% (at pixel time). The crisis could pose a test for the ECB’s bond buying programme, and the question is what options the ECB has, given questions about whether the OMT can be implemented.

However, some analysts are sanguine. Christian Schulz, an economist at Berenberg Bank, believes a new government would be “unlikely to endanger Portugal’s euro membership, as they would probably seek to continue a slightly modified adjustment programme.” But with the recent experiences of Greek and Italian elections, the reform agenda may take a back seat while political issues dominate.

Greece: Unnamed European officials were quoted by Reuters this week as expressing “a general dissatisfaction with progress in Greece when it comes to reforming its public sector, such as tax and custom collection or health care services.”

There were also reports that the Troika (the ECB, IMF and European Commission) had given Greece until the end of this week to deliver a reform agenda, or face the prospect that the next €8.1bn bailout tranche may be withheld.

The European Commission denied the report on Tuesday. However, on Wednesday, Greece’s finance ministry intimated that it cannot meet targets on reforming the public sector before the Eurogroup meeting next Monday.

If indeed Greece cannot deliver on the reform agenda, what would the ECB do to contain a potential crisis? The question is even more pertinent after the mixed messages from Angela Merkel, and Eurogroup president Jereon Dijsselbloem. Speaking to German newspapers, Merkel has rejected the possibility of new write-downs on Greek debt, while giving a confusing message on whether or not the next bailout tranche may be delayed.

Meanwhile, Dijsselbloem has insisted that there is no funding gap in Greece, only an issue with rolling over the debt (Greece has €2.2bn of debt to redeem next month). But if Greece did not manage to roll over its debt, and the IMF had to pull out of the bailout, how would the ECB contain the situation?

Cyprus: Cyprus recently restructured its debt (through an exchange of around €1bn of existing government bonds), which all three major ratings agencies deemed as a distressed exchange, and moved Cyprus’s credit ratings to default. Subsequently, the ECB temporarily suspended the eligibility of Cypriot government debt as collateral in its Eurosystem money operations.

European officials, including Mario Draghi, met with Cyprus President Nicos Anastasiades on Wednesday, to discuss the on-going implementation of the macroeconomic adjustment programme in Cyprus. The Bank of Cyprus’s balance sheet is due to be reviewed by the ECB next month. Markets will want to know when the results of the review can be expected, and when Cypriot debt is likely to be once again accepted as collateral.


According to previous comments by Draghi, the ECB stands ready to implement negative deposit rates (on banks parking their money with the ECB overnight), although he cautioned that there are “unintended consequences” to such a move. Given the challenges that hang over credit growth in the Eurozone, how has the ECB’s position evolved?

While the central bank seems reticent to implement such a policy, markets have been particularly reactive to talk of negative rates, and some suspect that Draghi could be using it to temper any rise in the value of the euro, given that the euro has been vulnerable to comments that entertain the possibility of a negative deposit rate.


In a speech in June, Draghi said “I would say that OMT is even more essential now as we see potential changes in the monetary policy stance with associated uncertainty in other jurisdictions of the integrated global economy.”

But the OMT is under threat. The German Constitutional Court’s ruling on the legality of the OMT – expected to come after the German election in September – is arguably the primary risk to the credibility of the ECB’s monetary policies. When it was announced last year, it vanquished questions about whether the euro could survive as a currency. Confidence subsequently improved, and sovereign debt yields in the Eurozone’s periphery came out of the danger zone.

There are, however, concerns that the OMT has removed incentives for peripheral nations to implement desperately-needed reforms. Christian Schulz, an economist at Berenberg Bank says “already fears that the OMT has lowered reform incentives in the periphery mean that it would take quite an intense new crisis wave to convince Germany’s parliament to vote in favour of ESM support programme as a pre-condition for the deployment of OMT,” and adds that “a weakening of the credibility of OMT remains the key risk to watch.”


The German Suddeutsche Zeitung newspaper recently reported that the ECB is considering outright Fed-style QE, as the central bank is concerned that the German Constitutional Court’s ruling could render the ECB’s backstops as irrelevant. The ECB has denied the report, calling the article unfounded.

From a markets perspective, it would be reassuring to see that the ECB is preparing contingency plans in case German lawmakers pull the rug from under the OMT programme.

But some are sceptical. Analysts at Rabobank said “we don't think [outright QE] would be realistic or warranted: the ECB has already more than enough trouble explaining why its OMT programme isn’t similar to monetary financing. But it will be more than happy to have yet another threat on its shelf.”

Ahead of the German election, Draghi’s comments will need to draw a fine between maintaining the ECB’s “whatever it takes” position, while reassuring Germany that it is committed to prudent monetary policy.


Talk aint cheap when central bankers speak. Central bankers are increasingly using ‘open-mouth’ operations to encourage the market to move in line with their policies. We’ve seen it from the Fed, the Bank of England, and this week the Reserve Bank of Australia’s governor Glenn Stevens used a speech to talk down the Aussie. Expect Draghi to use similar tactics.

We’d like to see journalists probing Draghi with regards to how far the ECB is prepared to go in terms of offering forward-guidance. Draghi is very exact and calculating in his choice of words; the expectation is that he will reiterate the ECB’s commitment to remaining accommodative, keeping rates low and liquidity on tap, but stop short of Fed-style forward guidance, where policy is attached to economic thresholds like unemployment, for example.


ECB board member Mersch recently said “the different elements of banking union are bound in a symbiotic way with each other,” adding that “forgetting or watering down individual parts endangers the success of the whole project.”

Despite the recent progress made on the Eurozone banking union, the project remains behind schedule. Last summer, policymakers estimated that the Single Supervisory Mechanism will be in place by the beginning of 2013 – it now looks as though it will be 2014 at the earliest. Additionally, the resolution mechanism may require a treaty change, and that is unlikely to materialise before 2015, according to some analysts.

And there are still unknowns hanging around the proposals. For example, the issue of bail-in rules, which still has some national discretion attached to it, and according to analysts at Bank of America Merrill Lynch “may reduce the efficacy in reducing fragmentation.”


A lack of credit growth is inhibiting investment growth, and by extension, employment conditions in Europe. Draghi has previously indicated that the ECB is considering measures to help SMEs, possibly through resurrecting the asset backed securities (ABS) market, and is examining its policy options.

At last week’s EU summit, leaders launched an investment scheme to support SME funding through the European Investment Bank (EIB), which aims to increase SME funding by 40% by 2015, and the EIB has reportedly identified €150bn of potential lending. Some have argued that ECB’s involvement in the ABS market is likely to be based on this scheme.

The key question is how risks may be pooled between the EIB, ECB and member states to support lending to European SMEs, given the ECB has shied away from direct action in the ABS market.

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