No Announced Changes at ECB Press Conference

January 14, 2010

ECB President Trichet unveiled no new policy steps today, nor did his verbal characterization of the euro area economy and ECB policy intentions break any new ground through the addition of new ideas or deletions of prior ones.  Current rates are appropriate.  Growth, which continued to be positive last quarter, has benefited from some temporary sources and will be only moderate and uneven in the period ahead.  Medium- to longer-term inflation expectations remain firmly anchored at the ECB target of below but close to 2.0%, even though actual inflation should be subdued and hover around a sub-target “1% in the near term.”  Drags on the pace of economic recover include low capacity usage, high and rising unemployment, and further balance sheet adjustments (i.e., deleveraging), plus additional downside risks such as the possibility of disruptive market movements (e.g., a spike upward in the euro), more intense protectionism, higher commodity prices, and negative feedback loops between the real economy and financial sector.  Growth forecasting risks, like inflation risks, are perceived to be broadly balanced.  Besides being uneven, growth prospects in the region also remain highly uncertain.  Negative on-year changes in loans to the private sector and M3 confirm the conclusion of the ECB’s economic analysis that price stability will persist in the longer term.

Since early May of last year, the ECB interest rate structure has been unchanged, consisting of a deposit facility rate of 0.25% and a marginal lending rate 0f 1.75% symmetrically flanking the key 1.0% refinancing rate.  These are the levels that ECB officials consider appropriate.  However, because market dysfunctionality interfered with the impact of such rates on the real economy, a separate “credit enhancement” program to support the banking system has been utilized and will continue.  As market conditions improve, and in order to avoid “distortions associated with maintaining non-standard measures for too long,” a gradual phase-out of such quantitative support will be undertaken, the first steps of which were unveiled at the December ECB press conference (see my ECB preview of January 13).  No new details on that phase-out were provided today.  Quantitative easing has enabled the Eonia overnight market rate to lie well below the 1% refinancing rate.  It’s presently around 0.33% and presumably will creep higher over the course of 2010 but not all the way back to 1%.  Liquidity will remain quite abundant for some time.  Officials have underscored that the gradual, progressive and timely unwinding of special liquidity support is not meant to imply any interest rate signal that investors need to act upon.

Questioned about the Greek deficit, Trichet said the ECB would not modify its collateral framework to accommodate that country or any single EMU member.  He is hopeful that a plan is being devised to consolidate Greek debt and put the deficit on a downward trajectory, and called speculation about Greece leaving the EU “absurd.”  In general, he urged all countries to begin the difficult process of reining in future deficits, to cut such eventually at an annual pace of more than 0.5 percentage points of GDP and to concentrate such efforts into reduced expenditures rather than higher taxation.

Trichet once again applauded the endorsement by U.S. officials of a strong dollar commitment and left no doubt that the ECB wants to avoid a situation wherein the euro appreciates cumulatively further against the U.S. currency.  G-7 central bankers will join finance ministers in Canada on February 5 and 6 at their first of three scheduled meetings of 2010.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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