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The ECB’s governing council decided to keep main interest rates unchanged today, following 25bp cuts on 11/3 and 12/8 of last year. The council iterated that the economic outlook remains subject o high uncertainty and substantial downside risks, inflation should moderate to below the 2% target after a number of months above 2%, and the pace of monetary expansion remains moderate.  

For more specifics, see this ECB press release:

http://www.ecb.int/press/pressconf/2012/html/is120112.en.html

However, more interesting than Mario Draghi’s prepared comments were his responses in the Q&A session. In particular, Draghi was quick to defend the workings of the LTRO to prevent credit contraction. While banks may be parking record amounts at the ECB’s overnight deposit, Draghi stated there’s initial evidence that money is circulating, especially as the banks that borrowed from the LTRO are not [all] the same banks re-depositing with the ECB. Mario Draghi’s (MD) responses are below:


Top 3 Q&A Responses:


How much of an uptick in the LTRO is coming up? Collateral changes were issued in the last meeting but, when do they come into effect?  –MD:  expect substantial demand in the second LTRO. Work is underway to make changes to collateral effective at the next LTRO, so in February [29th].

How successful is the LTRO? There are fears that money is just being parked at the ECB?  –MD: as more time passes we see that it is more and more successful. The decision (for the LTRO) that was given to all banks was an insurance against being without liquidity. It gave banks time to manage liquidity and assets and liabilities in a more effective way. We see some unsecured bank markets now open, which were previously closed. Also, 200B EUR in debt due is coming due in Q1.

Interest rates are declining across the yield curve, first on short end, now (today) more on long. So, there’s evidence that money isn’t just parked at the facility (ECB), it’s circulating. Initial signs of flowing include bids and behavior in accessing the LTRO depended on amount of bonds coming due for each institution in Q1. And by in large, banks borrowing were not [all] the same banks that are re-depositing with the ECB. Aware that more liquidity we inject, the larger the liabilities are for the ECB. What about the credit part?  Hard to judge, and there’s a lag in seeing money used to extend credit, but having said that, ECB thinks LTRO prevents credit contraction. The LTRO has come at the appropriate time to avoid credit contraction. 

Given the success of the LTRO, can the ECB lessen SMP purchases? – MD:  the rational of SMP is to unclog channels. The interbank market is still not functioning. Some opening is happening, but we’re really at the beginning of the process.


Additional Q&A:


Was today’s decision unanimous?  –MD:  yes, unanimous.

Thoughts on the ECB playing a larger role for the EFSF? –MB:  no comment.  Some of the stressed countries are taking serious measure for fiscal consolidation. Markets are showing some appreciation of this.  If one only limits itself for fiscal consolidation, one will have fiscal contraction over the short term.  One must understand this fiscal consolidation is unavoidable. Goal is to improve competitiveness, job growth, and confidence. And confidence comes from steady competition.  Therefore, the fiscal compact is key, and hopefully is signed this month rather than in March.

ECB will act as an agent for EFSF. Much progress has happened. We’re close to signing an agency agreement with EFSF. But the EFSF has a different task than the ECB. The ECB is responsible for price stability. The EFSF’s objective is completely different. But the ECB is prepared to put ‘technostructure’ (in the words of Trichet) at the disposal of the EFSF.

How confident are you that the economy is stabilizing?  -MD:  we see a weakening of economic activity in the Eurozone, see significant downside risk and a high level of uncertainty. Some data suggest stability at low levels, however it’s hard to be confident in initial positives.

Greece is looking towards higher haircuts, thoughts? – MD:  on PSI, one says more is needed… one needs to have in mind there is a debt sustainability assessment. There are a variety of factors. One thing is clear, Greece must bring back fiscal actions on track to complete fiscal reforms. The ECB is not part of the negotiations, just part of Troika.

It was previously communicated that main interest rate has a 1% floor, is that fair?  -MD:  we never pre-commit. In this situation of high uncertainty, we look at all factors and monitor all developments, then decide.

Could what happened to Philipp Hildebrand at the SNB happen at the ECB? – MD:  we all regret the developments that lead to his resignation. We’ll miss a very good CB governor. But we must say, the ethical code at ECB, which is public, prevents any such happenings.  [Draghi reads out statement on ethics code].

Did the governing council consider cutting deposit rate to prevent banks parking funds? –MD:  not discussed.

On Hungary, the ECB is critical of its CB legislation, what must Hungary do to address these concerns? –MD:  frankly, we’re very concerned because the ECB is extremely careful about pressures being put on NCBs. These pressures are inconsistent with EU treaties.

Besides PSI, would the ECB be prepared for a 100% write-down of Greek holdings, opinion? – MD:  the ECB is not in direct negotiations with Greece, so we hold our judgment. But there is no amount of sufficient relief if you don’t have fiscal consolidation and structural reforms. We [the public] focus on the relief side, but we must focus on the progress of fiscal reforms. ECB VP Victor Constancio:  stance is the same as before. PSI is private sector, so ECB is not involved in those negotiations. 

Is there the ability to combine the EFSF and ESM facilities together for a 1T EUR, opinion?  -MD:  I think anything governments can do to increase firepower is supported by ECB.

Stress tests revealed capital needs of banks, is there extreme stress across the system?  -MD:  well when the EBA survey was conducted, the EFSF wasn’t in place, so the survey is misleading. There’s no probability that the same exercise will be repeated in future. In the U.S., the banks had capital in place before the stress tests were issued.

Risk to ECB balance sheet, opinion? – MD:  there’s no doubt that expanding collateral rules also expands potential risks, but our risk management is very careful. Our system of potential haircuts and pricing is very developed. We’re very confident that we can manage the risks.

ECB’s position remains no PSI involvement on Greek bonds, but is it willing to accept losses on Greek holdings?  – Draghi calls Greece a unique case and has no direct answer to accepting losses.

Italy has done its “homework”, but debt is still very high, and market conditions are uncertain, opinion?  –MD:  the market appreciates what the country is doing, see yields falling today. Job creation should be first focus across countries.

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Matthew Hedrick

Analyst