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-- At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 1.00%, 1.75%, and 0.25% respectively. Draghi forecasts a very “gradual” to “slow” recovery in Eurozone GDP this year on account of increased foreign demand, low interest rates, structural reforms, and (with stress) an improvement in the risk environment as the major factor propelling this recovery.

To this last point, we’d say this is a large “gamble” considering that even if the market can cope with Greece, there are plenty of other peripherals that are not in a stable fiscal stead. Draghi also stressed the work of the two 36 month LTROs as decisive measures to put Europe back on track (remove “tail risk”) to see improvement, yet he wasn’t able to show material evidence that real lending has happened in response to these huge liquidity dumps, and called on governments and banks to continue reforms and repair balance sheets to support recovery. He did make it clear that they’re in a wait and analyze phase on the impact of the LTRO programs, and don’t have a third scheduled. While these comments are all well and good, we must not forget the pressures of reduced tax receipts to limit debt and deficits in an uncertain credit market, and the stresses on banks that are in the process of writing down their PIIGS paper and repositioning to meet higher capitalization ratios, mandated by June 30th.

Finally, and published after the call, the governing council decided to again accept as collateral any debt instruments that are issued or fully guaranteed by Greece. Yamas!

The language on its main economic outlook was unchanged, noting “signs of stabilization in economic activity at a low level” versus “substantial downside risks” in the February 9th report. The bank said it expects the Eurozone economy to “recover gradually in the course of this year”, but again was quick to say that “this outlook is subject to downside risks”. The Bank forecasts annual real GDP growth in a range between -0.5% and 0.3% in 2012 and between 0.0% and 2.2% in 2013. When compared with the December 2011 Eurosystem staff macroeconomic projections, the ranges have been shifted slightly downwards.

On inflation, the Bank holds roughly the same view, namely that inflation is “now likely to stay above 2% in 2012, mainly owing to recent increases in energy prices, as well as recently announced increases in indirect taxes, and they expect annual inflation rates should fall below 2% in early 2013. The March 2012 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation in a range between 2.1% and 2.7% in 2012 and between 0.9% and 2.3% in 2013. In comparison with the December 2011 Eurosystem staff macroeconomic projections, inflation forecasts have been shifted upwards, notably the range for 2012.”

Finally, Draghi noted the pace of monetary expansion remains subdued. The annual growth rate of M3 was 2.5% in January 2012, up from 1.5% in December 2011. Loan growth to the private sector also remains subdued. However, its annual rate (adjusted for loan sales and securitization) picked up slightly in January to 1.5% year on year from 1.2% in December. The annual growth rates of loans to non-financial corporations and loans to households (adjusted for loan sales and securitization) stood at 0.8% and 2.1% respectively in January.


Top Q&A Responses:

-If LTRO effects are not realized, what else can the ECB do?  Mario Draghi (MD): (laughs) both LTROs have such a complex and powerful effect, so we have to see how financial and economic landscapes have changed following operation. We must thoroughly analyze this.  We have done the LTROs, so now we want to see the effects.

-Regarding the Greek PSI, the ECB has swapped bonds that were exempt from CACs and the ECB has made no statement on this to date, can you comment?   MD: the bonds swapped were from our SMP bond purchasing program and were therefore in the public interest and deserve protection. The balance sheet of the ECB must be protected. Only when protected can the Bank issue price stability for the union.

-We’re in the third week without SMP purchases, is this program history?   MD: correct, inactive in the last 3 weeks. SMP is neither eternal nor infinite.

-How confident are you in the fiscal compact?   MD: I’m confident that the fiscal compact will be implemented. We need countries to give up a level of their national sovereignty around fiscal policy. We cannot have one or two countries pay for everyone else, nor under present conditions could we issue joint bonds. We need rules in place, “pillars of trust” if you will, between countries, and this trust is essential for a monetary union.

-Your thoughts on collateral rules?  MD: they could be looser. 

-Regarding Greece, markets are nervous on PSI, is this justified, or is it what you were expecting? What if PSI doesn’t get sufficient participation?  MD: markets are not nervous today, but rather happy, and they know more than I do.

-Should NCBs prepare for exit of Greece?   MD: there is no plan B; having such a plan would admit defeat. It would be to conceive a reality that goes beyond the treaty.

Additional Q&A:

-Interest rates in Germany are way too low, what happens when Germany heats up and rates in the Eurozone are too low?   MD: we must have monetary policy that is correct for the whole Union. Now, the rate is supportive and accommodative to maintain price stability.

-Last month you didn’t discuss interest rates moves, discussed this month?  MD: No

-Are you confident that Greek PSI will be a success?  MD: unfolding at present time, so inappropriate to comment.

-Overnight ECB deposits are high, are you worried about the LTRO’s impact?  MD: the rise in overnight deposits is just a mechanic consequence of the liquidity creation. We expect the deposit facility to go up in the immediate term, but adjust over the medium term. What we’ve seen is that the identity of the depositors and borrowers are different, so money is being circulated.

-Juergen Stark said today that the ECB balance sheet is shocking. Should we be worried?   MD: not sure what he meant. He agreed on the LTRO, but left before new collateral rules were issued. I will talk to him to see what he means.

-How concerned or upset are you about a leaked Bundesbank letter; are you concerned the ECB is not speaking with one voice?  MD: First I should say that my personal relationship with Jens is excellent. Nobody, contrary to the press, is isolated in the governing council. The ECB has cherished Bundesbank policy for price stability. But now, we’re all custodians of stability. The substance and content of the letter is present in all of our minds, including Target 2 balances. So we share these views. We are all in the same boat, and there’s nothing to gain in arguing outside of the council.


Matthew Hedrick

Senior Analyst